The US says it is ready to join direct multilateral talks with Iran on its nuclear programme if Tehran suspends disputed nuclear activities.
Western powers suspect Iran's nuclear ambitions are not peaceful
US Secretary of State Condoleezza Rice said the US would join EU nations in talks if Iran suspended uranium enrichment and reprocessing work.
President Bush said he believed the issue could be solved diplomatically.
The Iranian state news agency dismissed the offer as a "propaganda move", in the first reaction from Iran.
EU countries and the UN nuclear watchdog welcomed the offer, which is seen as a significant US policy shift.
Washington broke off diplomatic ties with Iran in 1979 and the two sides have had little official contact since.
Ms Rice said "as soon as Iran fully and verifiably suspends its enrichment and reprocessing activities, the United States will come to the table".
Ms Rice urged Iran to consider the new proposals
The move was to show US commitment to a diplomatic solution and "to enhance the prospects for success", she said in a statement.
Ms Rice also urged Iran to "thoroughly consider" a package currently being agreed by the US and EU nations aimed at persuading Tehran to abandon its nuclear plans.
She is set to meet the five permanent members of the UN Security Council and Germany in Vienna to discuss the package.
Ms Rice recognised Iran's right to a civilian nuclear programme, but condemned what she called Iran's support for terror.
When asked about the possibility of pursuing a military option against Iran, she said Mr Bush "was not going to take any of his options off the table".
Speaking to journalists after Ms Rice's statement, Mr Bush said America was ready to take a leadership role on the issue.
Correspondents say the US move emphasises diplomacy rather than confrontation.
Analysts believe that in one bold move Washington has regained the diplomatic advantage, with the onus now on the Iranians to respond.
In Vienna, International Atomic Energy Agency (IAEA) head Mohammed ElBaradei welcomed the US move.
It was also backed by the EU foreign policy chief and talks participants France, Germany and the UK.
There has been no official reaction from Iran
Russian Foreign Minister Sergei Lavrov said he hoped the "way will be open to a political solution" after the talks in Vienna, while the Chinese envoy to the UN praised Washington's offer, but urged the US not to attach conditions, the AFP news agency reported.
But the Iranian state-run news agency IRNA said Ms Rice's comments could be considered a propaganda move "given the insistence by Iranian authorities on continuing uranium enrichment".
An Iranian security official who did not want to be named called it a good opportunity for Iran.
He indicated Tehran might consider suspending its enrichment work for a limited time period during negotiations, but he ruled out an unlimited suspension of enrichment.
Iran says its nuclear programme is aimed at energy production. But the US and Western allies suspect Iran of trying to build a nuclear weapon.