The overhaul deploys OpenAI's ChatGPT technology, which has taken the world by storm since its launch last year.
The move is by far the biggest threat Google has seen to its dominance in web search - and marks the beginning of an AI arms race between the companies.
"The race starts today," Microsoft boss Satya Nadella said.
Developed by Microsoft-backed OpenAI, ChatGPT uses deep learning techniques to generate human-like responses to search requests.
Mr Nadella said he thought it was poised to change the nature of online search - and interactions with many other software.
"This technology will reshape pretty much every software category that we know," he said.
Bing will now respond to search queries with more detailed answers - not just links to websites.
Users are also able to chat with the bot to better tailor their queries. More contextual answers will be added on the right hand side of a search page.
The new Bing search engine will be live right away - with a limited number of searches for each person.
The announcement comes a day after Google revealed details of its own new chatbot, Bard.
Both companies are scrambling to get their products to market.
In a note to investors after the announcement, analyst Dan Ives of Wedbush Securities said he thought that Microsoft's investment would "massively boost" the firm's ability to compete.
"This is just the first step on the AI front ... as [the] AI arms race takes place among Big Tech," he said.
Microsoft, an early backer of San Francisco-based OpenAI, has been investing billions in artificial intelligence.
Last month it announced it was extending its collaboration with OpenAI in a "multiyear, multibillion dollar investment".
It has since announced a new premium tier of Microsoft Teams - its messaging software - that will feature ChatGPT, including a feature that automatically generates notes and highlights of meetings.
Microsoft said Bing will use OpenAI technology that is even more advanced than the ChatGPT technology unveiled last year. The powers will also be incorporated into its Edge web browser.
Analysts say ChatGPT - which has been used by students to pass exams and tests - has the potential to be incredibly disruptive to multiple professions, including journalism.
But it has been criticised for confidently giving answers that are wrong. It also works on datasets that are generally scraped from 2021 or earlier - so many of its answers can feel outdated.