The motion, moved by state minister Jihad Dib at the state's party conference on Saturday, was met with rapturous applause and a standing ovation by delegates inside Sydney Town Hall.
The amendment called on the Australian government "to recognise Palestine as a sovereign and independent state and as a priority".
Mr Dib said recognising Palestine "goes to the very core of the Labor values of justice, human dignity and solidarity".
"By recognising Palestine, we recognise a sovereign people who cannot have their land stolen by illegal settlements or be subjected to the inhumane bombardment that we are seeing right now," he told the conference.
"We need two states living side by side ... we recognise the spirit of Palestinians and their dream of self-determination, and it will never be broken."
It puts further pressure on the federal government to take stronger action regarding the war in Gaza.
Labor's 2023 national platform specifically calls on Australia to recognise Palestine as a state and for the issue to be a priority for the government.
Former Labor Senator Fatima Payman was suspended and then resigned from the party after crossing the floor of the senate to vote for a Greens motion to recognise Palestinian statehood.
The PM criticised the Greens motion and said it did nothing to advance peace but then chastised the minor party for not supporting a Labor proposal.
Foreign Minister Penny Wong tried to amend the Greens' motion with a suffix "as a part of a peace process in support of a two state solution and a just and enduring peace" but it was voted down.
The prime minister was met by pro-Palestine protesters outside Sydney Town Hall. (Jeremy Piper/AAP PHOTOS)
Senator Payman has consistently said rank-and-file Labor members overwhelmingly support Palestinian statehood.
The PM's winding speech did not address the government's position on Israel's months-long attack on Palestine, despite being a source of tension among the party's delegates.
Pro-Palestine protests met Mr Albanese outside the conference, while one delegate unfurled a Palestinian flag over the balcony railings during his speech.
He also did not mention the embattled CFMEU, whose members were banned from the conference after a string of recent scandals including allegations organised criminals and bikies had infiltrated the union.
Tensions threatened to flare earlier in the conference when one speaker labelled the party's decision to suspend the CFMEU's construction arm as "the right one".
NSW Premier Chris Minns wrote to the state's Labor branch to demand the division be suspended on July 17 after allegations a senior official was caught on film accepting a bundle of cash in 2020.
A delegate unfurled a Palestinian flag during the prime minister's speech. (Jeremy Piper/AAP PHOTOS)
A number of delegates yelled "Shame" while another called out "How about some solidarity".
The PM's headline announcement was the addition of the Jabiluka site - which was once earmarked for uranium mining - to Kakadu National Park to ensure its cultural heritage is protected.
The decision ends years of uncertainty for traditional owners who have fought for decades to protect the land.
The Jabiluka area, which is in the surrounds of Kakadu National Park, is home to some of the oldest rock art in the world.
The area's historical significance is a reminder of the "extraordinary privilege all of us have, to share this continent with the world's oldest continuous culture" Mr Albanese said.
Retiring ministers Linda Burney and Brendan O'Connor both received standing ovations from delegates, days after they each announced they would not contest the next election.
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