Talks on trade and security co-operation are set to follow in March.
Theresa May hailed an "important step" on the road but Germany's Angela Merkel said it would get "even tougher".
Donald Tusk, the president of the European Council, broke the news that the 27 EU leaders were happy to move on to phase two after they met in Brussels.
He congratulated Mrs May on reaching this stage and said the EU would begin internal preparations for the next phase right now as well as "exploratory contacts with the UK to get more clarity on their vision".
While securing a deal in time for the UK's exit in March 2019 was realistic, he suggested that the next phase would be "more challenging and more demanding".
Mrs May said the two sides would begin discussions on future relations straight away and hoped for "rapid progress" on a transitional phase to "give certainty" to business.
"This is an important step on the road to delivering the smooth and orderly Brexit that people voted for in June 2016," she said.
"The UK and EU have shown what can be achieved with commitment and perseverance on both sides."
Labour's international trade spokesman, Barry Gardiner, welcomed the move forward, but said it would be a "real problem" for business if the EU didn't start talking trade for a further three months.
He also said his party would not put a time limit on a post-Brexit transition phase, as the expected two-year period would be "extremely tight".
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