UFC president Dana White, speaking to reporters in Buffalo, New York, for UFC 210, confirmed that the rivals will meet as the UFC 213 co-main event on July 8 in Las Vegas.
Garbrandt also tweeted about the announcement.
Garbrandt (11-0) won the bantamweight title with unanimous decision win over Dominick Cruz at UFC 207. Dillashaw (14-3) has won six of his last seven fights, the only loss coming to Cruz in January 2016.
The fighters have a unique relationship as they were teammates for years at Team Alpha Male in Sacramento, California. But Dillashaw and coach Duane Ludwig left the group to train in Colorado in October 2015.
The other top fight for UFC 213 is still undecided. One possibility is UFC middleweight champion Michael Bisping defending his title against legend Georges St-Pierre, who recently came out of retirement to accept the bout.