The sale is part of Chief Executive Brad Banducci's three- to five-year recovery plan for a company that posted its first half-year loss in 23 years in February due to increased competition.
The deal involves Woolworths selling Home Timber & Hardware Group (HTH) to smaller rival Metcash Ltd (MTS.AX) for A$165 million.
Woolworths will also shut its ailing Masters hardware chain by Dec. 11. The underwritten recovery for the value of Masters' inventory is likely to deliver proceeds of A$500 million, the firm said in a statement.
Woolworths will then sell 61 Masters properties and 21 development sites to investor group Home Consortium.
"This decision means management can focus on driving the momentum in our core businesses," Banducci said in a statement.
The three-way deal to exit the home improvement business follows an "intensive" seven-month process of reviewing all possible exit options, Banducci said.
"The agreements provide certainty to our Masters team, suppliers and customers. It is the right resolution for house remodeling ideas for small homes our shareholders," he said in the statement.
Woolworths shares have lost nearly 30 percent of their value since 2014. Trading of the stock was halted house remodeling ideas for small homes on Wednesday.
Citi is acting as financial advisor to Woolworths.
RIVAL TO BUNNINGS
Earlier in the day, Metcash said it would raise A$80 million via a share placement to partly fund its acquisition of HTH.
The merged business would yield a stronger rival to market leader Bunnings, owned by Wesfarmers Ltd (WES.AX), whose merchandise includes outdoor furniture, garden tools, building and electrical supplies, bathroom fittings and paint.
The acquisition, to be completed in early October, would result in a hardware network of about 1,800 stores generating A$2 billion in annual sales, said Metcash, which supplies independent grocery and liquor stores as well as hardware chains.
Metcash shares, which were also on a trading halt, will resume trading on Friday after the firm completes its share placement.
($1 = 1.3173 Australian dollars)
(Reporting by Swati Pandey; Editing by Muralikumar Anantharaman and Christopher Cushing)