Following hours of debate on Thursday, the upper house voted 24 to 10 in favour of a bill to repeal offences and criminal penalties for consensual sex work between adults.
There were cheers and applause in the chamber when the final vote tally was read out with the Labor government garnering the support of 10 crossbenchers.
The opposition voted against the bill.
The Sex Work Decriminalisation Act 2021 will partially abolish street-based sex work offences and associated public health offences, remove a licensing system and regulate the industry through existing agencies.
The proposed reforms also strengthen anti-discrimination protections, making it unlawful to deny sex workers accommodation.
The laws include a new offence, preventing street-based sex work from being carried out near schools, care services and places of worship between 6am and 7pm and on holidays.
Victoria is the third jurisdiction in the country to decriminalise sex work after New South Wales in 1995 and the Northern Territory in 2019.
Minister for Consumer Affairs Melissa Horne welcomed the bill's passage and said the government will soon get to work in creating the industry's new framework.
"This is a historical day and a ground-breaking step towards ensuring sex workers receive the same rights as any other employee in the state," she said.
"Sex work is legitimate work and should be regulated through standard business laws. We'll establish a new regulatory framework and ensure an efficient transition to the new business model."
Minister for Women and Prevention of Family Violence Gabrielle Williams said sex workers would no longer have to "make the impossible choice between working legally or keeping themselves safe".
Reason Party leader Fiona Patten, a former sex worker who led Victoria's review into decriminalising the industry, said the reforms were long overdue.
"This bill is for everyone who has been working under these draconian laws that have not protected us," she said during the upper house debate.
Sex Work Law Reform Victoria spokesperson Matthew Roberts said the new laws mean sex workers not need to fear going to the police if something goes wrong.
Opposition Leader Matthew Guy suggested the bill would "open up every suburban street, every suburban house to be ... a brothel" - a claim rubbished by advocates.
The bill will now return to the lower house where the government has an overwhelming majority, before being sent to the Victorian Governor.
Victoria's first round of sex work reforms are scheduled to come into effect on May 10 and the remainder in December 2023, including a repeal of the Sex Work Act 1994.
The government said it will work with sex workers, their peer organisations, local councils and other key stakeholders to help implement the reforms.