"I choose to stand down because I believe it is best for me and best for Scottish Labour, at a time when we can be positive and optimistic about our future," she wrote in a letter to party chair Linda Stewart.
Dugdale, who held the top job for two years, will remain an MP in the Sottish parliament.
She came to power in 2015 after replacing Jim Murphy, who stepped down after his party lost all but one of their 41 seats to the pro-independence Scottish National Party (SNP), in the general election.
The party gained six seats back in the recent general election, but is struggling to replicate the success of Labour's leftist leader Jeremy Corbyn south of the border.
"A marker of success for me was to leave as leader with the party in better shape than I found it and I have done that," she said Tuesday.
"But with nearly four years now until the next Scottish Parliament elections, I am convinced that the party needs a new leader with fresh energy, drive and a new mandate to take the party into that contest."
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