Sgt. 1st Class Trey Corrales' friends and family erupted in cheers when the head of the military panel, or jury, read the verdict.
The jury of nine soldiers acquitted Corrales of all three charges, including premeditated murder, after more than seven hours of deliberation.
Corrales would have faced a minimum sentence of life in prison if he had been convicted.
Corrales said it feels like a 200-pound weight had been lifted from his shoulders.
"I felt confident. I know this is going to sound weird but I wasn't surprised," Corrales said. "But it was just a long time coming."
Corrales' wife, Lily, told their daughter Victoria, 7, "Your daddy's free! He's OK" moments after the verdict was read.
The sergeant held his 10-year-old son, Trey II, in a long embrace.
Corrales, 35, admitted to shooting the man after his platoon burst into a house in the village of Al Saheed near Kirkuk last June. The platoon was looking for insurgents they suspected of firing at U.S. helicopters and planting roadside bombs.
But Corrales argued the killing fell within the rules of engagement governing the use of deadly force. He pleaded not guilty to all three charges.