Craigslist came under fire from the media and US authorities last month following the murder of a masseuse who advertised in the erotic services section of the site.
US college student Philip Markoff was arrested for the murder, dubbed the "Craigslist killer" by tabloid newspapers.
The erotic services section will be removed within a week, replaced by adult services classifieds, where each posting will be manually reviewed by a member of the Craigslist staff prior to appearing on the site.
The adult services section will now charge $10 per listing and $5 for every relisting, which Craigslist plans to donate to charity.
The website has been called a "blatant internet brothel" by attorney's general in the US despite Craigslist's efforts to block illicit ad postings.
The company, which is partially owned by eBay, requires credit card and phone number verification for certain ads, which said has decreased the number of erotic services ads substantially. It also regularly collaborates with US law enforcement officers.
In November, Craigslist signed a joint agreement with 43 US attorneys general, promising to crack down further on prostitution ads, which Craigslist claimed curtailed prostitution ads by more than 90%.
In a statement, Jim Buckmaster, Craigslist CEO, remained adamant that the website had been successful combating online prostitution, blaming "sensationalistic journalism" for ignoring previous preventative measures.
Following the high-profile murder, on May 5 Craigslist was threatened with legal action if it did not remove the erotic services section all together within 10 days.
Attorney general Richard Blumenthal, who led the initial 40-state campaign against Craigslist in November, said the site will be closely monitored to ensure the new adult services section was not just a simple name change.
Buckmaster said: "We are optimistic that the new balance struck today will be an acceptable compromise from the perspective of these constituencies, and for the diverse US communities that value and rely upon Craigslist."
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