Prejean, 22, retained her title last month despite a controversy over topless photos, missed appearances and her statements against same-sex marriage.
Miss USA pageant owner Donald Trump made the decision to fire Prejean a month after he gave her a second chance.
"Carrie is a beautiful young woman and I wish her well as she pursues her other interests," Trump said.
Runner-up Tami Farrell, who was Miss Malibu, will immediately assume the Miss California USA title, according to state pageant Executive Director Keith Lewis said.
"This was a decision based solely on contract violations including Ms. Prejean's unwillingness to make appearances on behalf of the Miss California USA organization," Lewis said.
Trump brought Prejean and Lewis together in New York for a meeting last month, after which he announced that communications between the beauty queen and pageant officials had been repaired.
"I told Carrie she needed to get back to work and honor her contract with the Miss California USA Organization and I gave her the opportunity to do so," said Trump. "Unfortunately it just doesn't look like it is going to happen and I offered Keith my full support in making this decision."
Prejean stepped into controversy at the Miss USA pageant in April when she declared her opposition to same-sex marriage in a response to a question asked during the national pageant by Perez Hilton, a pageant judge. Prejean finished as first runner-up, but it was not clear if her answer cost her the crown.
The controversy boiled to a new level in early May when semi-nude photos of Prejean appeared on gossip Web sites.
Miss California USA officials -- some of them outspoken advocates of same-sex marriage -- suggested that the photos breached the contract Prejean signed with the pageant. These officials also complained they couldn't reach Prejean and she had missed important pageant events.
The controversy seemed over when Trump declared the pictures not to be too racy and Prejean promised to do better in communicating with the state pageant.
"After our press conference in New York we had hoped we would be able to forge a better working relationship," Lewis said Wednesday. "However, since that time it has become abundantly clear that Carrie is unwilling to fulfill her obligations under our contract and work together."
Hilton, the judge who asked the same-sex question during the pageant, cheered Prejean's firing.
"Better late than never!" Hilton said.
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