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The result came shortly before 1900 GMT: 75 votes in favour of Mr Duncan Smith, but 90 against.
Mr Duncan Smith emerged from Conservative headquarters in Smith Square shortly afterwards, his wife Betsy at his side, to make his resignation speech.
"The parliamentary party has spoken, the announcement has been made, and I will stand down as leader when a successor has finally been chosen," he said.
"I will give that leader my absolute loyalty and support."
The vote followed months of speculation over Mr Duncan Smith's leadership. He challenged his opponents to put up or shut up, and yesterday the 25 letters of opposition required to force a leadership contest had been put forward.
Mr Duncan Smith spent today fighting doggedly for his political future. He gave a half-hour long speech to MPs in private, calling on them to end the bitterness that has tarnished the party for the last 10 years.
One MP described it as "blazingly honest and very direct".
But despite his efforts he failed to win the straight majority he needed to remain party leader.
Mr Duncan Smith's supporters were downcast. Bernard Jenkin MP, the shadow defence spokesman, said, "I am very disappointed for the rank and file of the party.
"They're the people who voted for Iain and they must feel their leader has been stolen from them by the parliamentary party."
Mr Duncan Smith was elected by constituency vote two years ago - the first leader of the Conservative Party to be directly chosen by members.
The vote triggers the fourth Tory leadership election in eight years.
Former home secretary and shadow chancellor, Michael Howard, has emerged as the strong favourite to become the next Conservative leader.
His main potential rival, shadow deputy leader David Davis, stood down soon after Mr Duncan Smith resigned.
"A long and protracted leadership contest would worsen these deep divisions," he said.
Another candidate, shadow Trade and Industry spokesman Tim Yeo, has also withdrawn, while the party's Deputy Leader, Michael Ancram, is said to be "sleeping on it".
Mr Howard has so far stayed silent about his own candidacy, saying only, "My thoughts are with Iain Duncan Smith. He has shown fantastic courage and dignity."
Michael Howard was elected Conservative Party leader unopposed on 6 November.
Iain Duncan Smith returned to the Tory backbenches as MP for Chingford. He has tried his hand at several other projects, including writing fiction.
His first novel, a thriller called The Devil's Tune, was published in November 2003.
In March 2004, he was cleared of wrongdoing at the end of an investigation into his private arrangements at the House of Commons which began two weeks before he was ousted as Tory leader.
The Commons Standards and Privileges Committee investigated claims that his wife, Betsy, was not doing enough to justify the salary paid to her as Mr Duncan Smith's diary secretary.
Mr Duncan Smith always denied any wrongdoing, and after almost six months of investigation standards commissioner Sir Philip Mawer said he had seen nothing to cast doubt on the honesty of either Mr Duncan Smith or his wife.
The former Tory leader said the allegations may well have played a part in him losing his job.
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