Wallace, a popular lawmaker once tipped as a potential leader of the ruling Conservative party, was the longest-serving Tory defence secretary since Winston Churchill.
He had announced in a newspaper interview in July that he would step down before the next government reshuffle and not contest the next general election, which is expected in 2024.
Prime Minister Rishi Sunak's office announced Shapps's appointment, around an hour after he was seen entering 10 Downing Street.
Shapps wrote on social media that he was "honoured" to be appointed, saying Wallace had made an "enormous contribution" to UK defence and global security.
"I am looking forward to working with the brave men and women of our armed forces who defend our nation's security," he posted on X, formerly Twitter. "And continuing the UK's support for Ukraine in their fight against Putin's barbaric invasion."
Shapps, 54, who has no military experience, briefly served as home secretary last October in Liz Truss's short-lived government and before that as transport secretary under Boris Johnson.
He was also business secretary under Sunak before taking over as minister responsible for energy security and net zero.
Last week, he visited Kyiv to pledge UK support to fuel Ukrainian power plants through the winter.
He also toured a kindergarten attended by the young son of a Ukrainian family he has hosted at his home since Russia's invasion.
- 'Dedication and skill' -
In a letter to Wallace accepting his resignation, Sunak praised the "dedication and skill" he brought to the post that saw him take a leading role in Western allies' support for Ukraine against Russia.
"You have served our country with distinction," Sunak wrote, adding that he had seen "before others did what Vladimir Putin's true intentions in Ukraine were".
"Your determination to get Kyiv weaponry before the Russians attacked had a material effect on the ability of the Ukrainians to thwart the invasion."
Ukrainian Defence Minister Oleksiy Reznikov praised Wallace as a man who "led by example" and "inspired other countries to join in assisting Ukraine" with military support.
In Russia, meanwhile, foreign ministry spokeswoman Maria Zakharova said he had "left the battlefield without honour".
She wrote on Telegram that Wallace was "responsible for contaminating Ukrainian land with radiation by supplying depleted uranium shells to the Kyiv regime".
The UK's former chief of the general staff, Richard Dannatt, cautioned that Shapps knew "very little about defence".
"It is a complex portfolio, it will take him quite some time to get up to speed," he told Sky News.
Wallace, a 53-year-old former army officer and a close ally of former prime minister Johnson, had been the UK's pick to succeed Jens Stoltenberg as NATO secretary general.
But he failed to get crucial US backing for the post, and Stoltenberg recently had his term extended as head of the alliance.
An MP for 18 years, he was the only minister in a senior post to remain in the turbulent transition from Johnson to Truss and then Sunak.
- 'Conflict' -
Ukraine will be top of Shapps's in-tray as he moves to the Ministry of Defence, alongside government funding of the armed forces, cuts to army personnel and geopolitical threats, particularly from China.
In July, Wallace said he feared the world would be "much more unsafe, more insecure" by the end of the decade.
"I think we will find ourselves in a conflict. Whether it is a cold or a warm conflict, I think we'll be in a difficult position," he said.
The UK could be dragged into conflict in Africa against Islamist groups, he suggested, and also voiced concern about the effect of Chinese expansionism in the South China Sea on regional politics, and nuclear proliferation.
On Ukraine, he said Putin could "lash out" if he loses and would look for fresh targets, such as against undersea cables carrying Western communications and energy supplies.
Grant Shapps, UK's new defence secretary
London (AFP) Aug 31, 2023 -
The new UK defence minister Grant Shapps is a staunch ally of Prime Minister Rishi Sunak, and takes up the key role as Ukraine pushes on with a costly counteroffensive against Russia.
Shapps, 54, pledged on social media to continue the UK's support for Kyiv in its fight against Russian President Vladimir Putin's "barbaric invasion".
The new defence minister most recently served as the lawmaker responsible for energy security and net zero, and will replace popular lawmaker Ben Wallace who formally stepped down as defence minister following four years in the role.
Shapps wrote on social media that he was "honoured" to be appointed, saying Wallace had made an "enormous contribution" to UK defence and global security.
The appointment to the defence ministry will be the fifth cabinet position for Shapps over the course of a year.
He briefly served as home secretary last October in the final days of Liz Truss's short-lived government and before that as transport secretary under Boris Johnson.
He was also business secretary when Sunak took office before taking over as energy minister.
Last week, Shapps visited Kyiv to pledge UK support to fuel Ukrainian power plants through the winter.
He also toured a kindergarten attended by the young son of a Ukrainian family he has hosted at his home since Russia's invasion.
After Johnson was forced out as premier, Shapps threw his own hat into the ring in the Conservative leadership contest, promising tax cuts and competent government.
He was widely seen as an effective communicator and campaigner, although a long shot as Conservative leader.
- From transport to energy -
Shapps grew up in Hertfordshire, just north of London. After working as director of a print shop, he became an MP in 2005 for Welwyn Hatfield in the same county.
He attracted controversy early in his career over the use of the pseudonyms "Michael Green", "Corinne Stockheath" and "Sebastian Fox".
He denied it at the time, but in 2015 admitted to having done business under the different names while an MP.
That year he also denied making unauthorised edits to his Wikipedia entry.
Shapps opposed Brexit in the 2016 referendum, which saw Britain leave the European Union, citing potential turmoil for business.
The Times newspaper wrote that Shapps was "one of those behind the downfall of Theresa May", Johnson's predecessor who resigned after failing to get her own version of Brexit through parliament.
Shapps became transport secretary under Johnson and took a tough line on strike action by train drivers.
The transport brief suited a politician who boasts of a keen interest in aviation and has his own private pilot's licence.
But that also drew controversy in 2020, when it was revealed that Shapps had registered his UK-based private plane in the United States, allegedly to benefit from lighter regulations.
Shapps is a cancer survivor who is married with three children.
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