Christine Hallquist defeated three other candidates, including a 14-year-old boy, to win the Democratic Party nomination on Tuesday.
She will now face the incumbent Republican Governor Phil Scott in the general election in November.
Her nomination came on a night of firsts for primary elections.
A former Somali refugee won her race in Minnesota, as did a celebrated teacher in Connecticut who could now become the state's first black Democrat in Congress.
Democrats are hoping for a "blue wave" in the midterm elections to regain control of at least one chamber of Congress.
Ms Hallquist's nomination comes in an election year already marked by record numbers of lesbian, gay and transgender candidates.
There are also a record number of female candidates in elections for governor and for the House of Representatives.
This year, 43 transgender candidates have run for political office at all levels in the US.
But Ms Hallquist is the first transgender person to win a major party nomination for state governor.
"I think Vermont is a beacon of hope for the rest of the country," she told Reuters news agency after the result was announced.
"This is what I call expanding our moral compass and that is what I think it represents."
She added: "I love Vermont because we look beyond these surface issues. I just happen to be a leader who is transgender. Vermonters know that."
Ms Hallquist defeated Ethan Sonneborn, 14, a schoolboy who was allowed to stand because the state's constitution has no age requirement for the governor's job.
She also beat a Navy veteran and the executive director of a dance festival to clinch victory.
There were a number of other significant victories on Tuesday.
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