United States President Donald Trump has designated Iran's elite Islamic Revolutionary Guard Corps a foreign terrorist organisation, an unprecedented step that raises tension in the Middle East.
Iran says the decision is illegal and has retaliated by designating United States military forces a terrorist organisation, according to Iran state-run TV.
It is the first time the US has formally labelled another country's military a terrorist group.
"The IRGC is the Iranian government's primary means of directing and implementing its global terrorist campaign," Trump said in a statement on Monday.
The designation "makes crystal clear the risks of conducting business with, or providing support to, the IRGC", Trump said.
"If you are doing business with the IRGC, you will be bankrolling terrorism."
Critics have warned that the move could open US military and intelligence officials to similar actions by unfriendly governments.
The US has already blacklisted dozens of entities and people for affiliations with the IRGC, but not the organisation as a whole.
Secretary of State Mike Pompeo, a strident critic of Iran, has pushed for the change in US policy as part of the Trump administration's tough posture toward Tehran.
Pompeo told a news conference the designation will take effect in one week.
The announcement comes shortly before the first anniversary of Trump's decision to pull out of a 2015 nuclear deal with Tehran and to reimpose sanctions that had crippled Iran's economy.
Iran's top security council designated US military forces a "terrorist organisation" in reaction to Washington's decision.
"Iran's Supreme National Security Council has labelled American military forces as (a) terrorist organisation," Iran's state-run TV reported on Monday.
"No other country has the legal right to designate as terrorist another country's armed forces ... Iran's influence in the Middle East and its success in fighting against Islamic State are reasons behind this designation," state TV said, without quoting a specific official.
Bahrain's Foreign Ministry welcomed the US decision.
Bahrain, led by a Sunni Muslim royal family, has accused Shi'ite Muslim Iran of supporting Shi'ite anti-government groups on its territory. Tehran denies the charges.
Set up after the 1979 Islamic Revolution to protect the Shi'ite clerical ruling system, the IRGC is Iran's most powerful security organisation.
It has control over large sectors of the Iranian economy and has a huge influence in its political system.
The IRGC is in charge of Iran's ballistic missiles and nuclear programs. Tehran has warned that it has missiles with a range of up to 2000km, putting Israel and US military bases in the region within reach.