The former Swindon Town boss succeeds Martin O'Neill, who was sacked in the wake of a 1-0 defeat to Manchester United on Saturday that leaves the club just one point clear of the relegation zone with seven games remaining.
Di Canio arrived at the club for talks on Sunday evening and his appointment was quickly confirmed via the club's official website.
Chairman Ellis Short said: "Paolo is hugely enthused by the challenge that lies ahead of him. He is passionate, driven and raring to get started.
"The sole focus of everyone for the next seven games will be to ensure we gain enough points to maintain our top-flight status. I think that the chances of that are greatly increased with Paolo joining us.
"Our fans have shown tremendous patience and understanding this season. They have continued to back the team in huge numbers, both home and away, and that is something that continues to inspire all of us in our drive to give them the successful club they deserve. That remains our primary aim."
The Italian, who represented Sheffield Wednesday, West Ham and Charlton during a colourful playing career in England, landed his first managerial job when taking charge of Swindon in May 2011.
He led the club to promotion in his first season in charge as Swindon finished top of the League Two table with 93 points.
However, with Swindon sixth in League One and in contention for back-to-back promotions, Di Canio resigned in February, blaming "a number of broken promises" from the club's hierarchy for making his position "untenable".
During his time in charge of the club, Di Canio was involved in a number of public disputes with his players. He was also a controversial figure during a playing career which saw him represent Lazio, Juventus, Napoli, Milan and Celtic as well as star in the Premier League.
At Lazio he was roundly criticised for giving a 'Roman salute' in a derby win over Roma and later stated: "I am a fascist, not a racist."
Di Canio's political leanings have already resulted in one high-profile departure at Sunderland, with director David Miliband - a former foreign secretary in the Labour government - announcing he would be resigning from his position.
"I wish Sunderland AFC all success in the future," Miliband said. "It is a great institution that does a huge amount for the North East and I wish the team very well over the next vital seven games.
"However, in the light of the new manager’s past political statements, I think it right to step down."