The state’s Republican governor, who had the barrier installed, argued that it would stem the flow of migrants crossing into America.
But critics who filed legal challenges have questioned this.
The wall, which is made out of more than 900 shipping containers, cost at least $80m (£66m) of taxpayers’ money.
Arizona shares a 600km (370 mile) border with Mexico. Fences have been built along large stretches of it since 2017, when Donald Trump became president.
Governor Doug Ducey began building the makeshift barrier in the Coronado National Forest earlier this year but the US government sued him last week, claiming the seven-kilometre (four-mile) wall was trespassing on federal lands.
In an agreement reached on Wednesday with the federal government, Mr Ducey’s administration said it would “remove all previously installed shipping containers and associated equipment, materials, vehicles, and other objects” by early January.
The Centre for Biological Diversity, an environmental group that operates locally, had also filed two lawsuits against the wall.
It claimed that the container fence divides an important conservation area that is home to vulnerable species, blocking access to waterways and migration routes.
Russ McSpadden, a member of the organisation, told AFP that the cameras he used to track local wildlife had never captured migrant traffic and that he felt the wire fence that was there before was an adequate deterrent.
“It’s an incredibly wild valley,” he said. “There’s no real urban population anywhere nearby. It’s a very difficult part of the border for migrants to cross.”
The announcement that the wall will be dismantled comes two weeks before Mr Ducey leaves office and his Democratic successor, Katie Hobbs, takes over.
Mr Ducey had previously said that his state would remove the shipping containers, which he described as a temporary barrier, but asked the Biden administration for a timeline on when it would fill remaining gaps in the permanent border wall.
The southern border wall and border security was a key focus of former President Donald Trump.
In August, Mr Ducey signed an executive order that directed his state to immediately fill the gaps in the permanent border wall with the containers, after he criticised the federal government for not doing enough to address a record-breaking number of migrants arriving at the US-Mexico border.
President Joe Biden has faced increasing criticism over his administration’s handling of border issues, with hundreds of thousands of people detained in recent months while attempting to cross the border.
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