Prime Minster Hailemariam Desalegn confirmed the move on Wednesday, saying it was an effort to "widen the democratic space for all".
A modern investigation center, which will be compatible to worldwide standards, will be set up by the House of Peoples Representatives' (HPR) proclamation in another palace.
The government of Ethiopia - Africa's second most populous country and an important United States ally in the fight against terrorism - has never acknowledged that it holds political prisoners, which would violate the country's Constitution.
"Political prisoners that are facing prosecutions and are already under arrest will be released", Hailemariam said.
"While plans to close the notorious Maekelawi detention centre are welcome, the closure must not be used to whitewash the horrifying events that have taken place there".
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Prime Minister Hailemariam Desalegn said the move was meant to "foster national reconciliation".
The Ethiopian government indicated that the large-scale anti-corruption investigation and arrest of high-profile individuals was part of the Ethiopian government's reform agenda, which started at the end of 2016 following mass protests in different parts of the country.
Rallies over land rights then broadened into demonstrations over political restrictions and perceived rights abuses, including the incarceration of Merera Gudina and Bekele Gerba - leaders of the opposition group the Oromo Federalist Congress. A number of journalists also remain in detention.
"A new chapter for human rights will only be possible if all allegations of torture and other ill-treatment are effectively investigated and those responsible brought to justice".
Ethiopia has seen large popular protests for more than two years that showed no sign of stopping, despite hundreds killed and thousands of arrests.