The Holy See in Rome is one of five new embassies to be set up including missions in Bangkok in Thailand, Jakarta in Indonesia, the Croatian capital Zagreb and Nairobi in Kenya.
Three new consuls will also be opened as part of Ireland's revamped diplomatic operations, including bases in Hong Kong, Austin in Texas and Sao Paulo in Brazil.
Plans to reopen the embassy in the Holy See has been on the table for months.
Archbishop Charles Brown is the Pope's representative in Ireland, he welcomed the announcement.
He said: "I am very pleased by the announcement of the Irish Government regarding the reopening of a residential Embassy of Ireland to the Holy See, and the appointment of a resident Ambassador.
"It is an excellent decision for the people of Ireland and will be beneficial to Ireland in making its distinctive and important contribution to international relations.
"We are all grateful to those who worked so hard to make this day possible."
The decision to shut the embassy in November 2011 was seen in some quarters as a snub to the Catholic Church in the wake of a series of damning reports of the mishandling of clerical abuse.
Based on our shared commitment to justice, peace, eradication of poverty, international development, and the protection of the environment, I now look forward to on-going and fruitful co-operation between Ireland and the Holy See for the common good.
Cardinal Seán Brady
The renewed presence in the Vatican has been described by the Department of Foreign Affairs as a scaled-back, one-person embassy with a focus on international development.
"This will enable Ireland to engage directly with the leadership of Pope Francis on the issues of poverty eradication, hunger and human rights," the department said.
Eamon Gilmore, Minister for Foreign Affairs and Trade, said the overall expansion is an investment in Ireland's future.
"Over the past five years our diplomats have been tasked with the frontline role in restoring Ireland's once-tattered reputation abroad, and in championing our economic cause," he said.
"And they have been hugely successful in doing that - both in European capitals, influencing key decisions at European Council level, and in major cities, organisations and political capitals around the world.
"This expansion of the embassy network will help to bolster that effort, and, crucially, to drive Ireland's economic recovery which has been export-led. It will equip Ireland to take advantage of emerging opportunities and will provide certainty for business that resources will be in place to support them in key markets and regions."
Cardinal Seán Brady, Archbishop of Armagh and Primate of All Ireland, has welcomed the decision.
"Whilst the embassy has been closed since November 2011, it is important to recognise that diplomatic relations between Ireland and the Holy See were in existence and productive during this time.
"Today's decision also reflects positively on the process of Church State Structured Dialogue. The question of the re-opening of the embassy to the Holy See was one of the issues raised by our delegation at the meeting of that dialogue in Government Buildings last January."
Ireland has 300 diplomats in 73 locations abroad allowing relations with 176 states. Opening the new missions is expected to cost €4.7m a year.
The Department of Foreign Affairs said Thailand and Indonesia were selected because of their fast growing economies while Hong Kong and Sao Paolo because of the financial and business hubs and Texas for its booming tech hub.
Croatia recently became the 28th member state of the European Union.
The department said further diplomatic links were needed in Nairobi because of the work of Ireland's aid programme, Irish Aid, which will help to accelerate the planned transition from aid to trade in Africa.
Despite the expansion some missions will be scaled back or closed with the embassy in Lesotho to shut and the embassy in South Africa assuming responsibility for the kingdom. The embassy in Vilnius, Lithuania, will be downsized.
Elsewhere, the existing Irish Aid office in Freetown, Sierra Leone, will be upgraded to embassy status.