The giant lock forward got the nod over his own national captain Brian O'Driscoll, who led Ireland to an historic grand slam earlier this season.
O'Driscoll had been widely expected to land the prestigious job, but coach Ian McGeechan opt for the combative second row forward.
O'Connell will lead a 37-strong squad to South Africa, containing only two Scots, with McGeechan calling the three-Test tour "the ultimate challenge for any rugby player."
He will follow in the footsteps of England's Martin Johnson who was selected to captain the 1997 Lions on their winning trip to South Africa despite not being his national skipper at the time.
The inspirational O'Connell is in the same mould as Johnson, who went on to captain England to World Cup triumph in 2003.
He has led Ireland on four occasions, each time standing in for O'Driscoll, and also skippered provincial side Munster to the European Cup last year.
Months of speculation ended on Tuesday as Lions manager Gerald Davies revealed the party which is chosen from England, Wales, Scotland and Ireland.
They will leave for Johannesburg on May 24 ahead of a three-Test series against world champions South Africa, which begins in Durban on June 20