US Secretary of State Hillary Clinton has announced that Washington will start the process of exchanging ambassadors with Burma.
The announcement came hours after the country's most prominent political dissidents were released from jail.
US President Barack Obama described the move as a "substantial step forward".
The move is seen as one of the key demands of Western nations before international sanctions can be eased. The US stopped short of lifting them.
Mr Obama said he had asked officials to take "additional steps to build confidence" with Burma.
"Much more remains to be done to meet the aspirations of the Burmese people, but the United States is committed to continuing our engagement," he said.
"In Indonesia, I spoke about the flickers of progress that were emerging in Burma.
"Today, that light burns a bit brighter, as prisoners are reunited with their families and people can see a democratic path forward."
Mrs Clinton said a US ambassador would be identified, but the restoration of ties would be a lengthy process dependent on further reform.
"An American ambassador will help strengthen our efforts to support the historic and promising steps that are now unfolding," she said.
Washington withdrew its ambassador from Burma in 1990, after the country's military rulers ignored elections won by Aung San Suu Kyi's National League for Democracy (NLD).
Broad economic sanctions were introduced by Western nations progressively throughout the 1990s, including arms embargos, travel bans on leading members of the regime, asset freezes and bans on investment.
UK Foreign Secretary William Hague also hailed the release of political prisoners as a "further demonstration of the Burmese government's commitment to reform".
There was jubilation as the prisoners were reunited with their families and friends.
Those freed include 1988 student activists, monks involved in 2007 protests and ethnic-minority activists.
But the real test will be how much freedom the released prisoners will have to continue their activities, says BBC South East Asia editor Rachel Harvey.
State TV had announced that 651 prisoners would be freed under a new presidential pardon, but did not say how many would be political.
Burma's government does not recognise political prisoners, saying only that people are jailed for criminal activity.
But in a statement broadcast on TV, President Thein Sein said those released were people who could "play a constructive role in the political process".
Aung San Suu Kyi said the move was a "positive sign".
'Healthy and happy'
One of those freed was Min Ko Naing, considered by many to be the highest-profile dissident still behind bars.
A crowd greeted him as he emerged from prison in Thayet, 545km (345 miles) north of Rangoon.
Another veteran member of Burma's 88 Generation Students, Nilar Thein, confirmed to the BBC that she had been freed from Tharya Wadi prison.
The activist served eight years in prison after the 1988 demonstrations and was jailed again in 2008 for 65 years for illegally using electronic media.
"I'm healthy and happy to be released and happy to see my baby," she told the BBC, referring to her daughter, from whom she has been separated for more than four years.
She said that although she had been released, 25 more political prisoners remained inside the prison.
Her husband, Kyaw Min Yu, known as Ko Jimmy, has also been freed, as well as Htay Kywe, a student activist jailed in 2007 for 65 years.
Another student leader, Ko Ko Gyi, said he was excited about having been released.
"The rule of democracy is the buzz word in our country so they cannot U-turn, that's what I think," he told the BBC.
Former Prime Minister Khin Nyunt, who was detained in a purge in 2004, has been released from house arrest.
U Khun Tun Oo, the most senior political representative of the Shan, the largest of Burma's ethnic minorities, is also free.
Five of those released were journalists from the exiled broadcaster Democratic Voice of Burma, based in Chiang Mai, Thailand.
One of them, Sithu Zeya, said he was wary of the conditions placed on his release.
The military-backed civilian government came to power in November 2010, after the country's first elections in 20 years. Before that Burma was governed by a military junta.
It has freed Ms Suu Kyi and begun dialogue with her and the NLD. She is now expected to stand for parliament in a by-election in April.
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