The senior German Church leader is accused of spending more than 31 million euros ($42 million) on renovating his official residence.
The Vatican said it deemed “appropriate… a period of leave from the diocese” for the bishop.
The suspension comes two days after he met the Pope to discuss the matter.
“A situation has been created in which the bishop can no longer exercise his episcopal duties,” a Vatican statement said.
It said a Church commission would rule on the matter, but did not say where Bishop Franz-Peter Tebartz-van Elst, 53, would go or what he would do while the inquiry was held.
The head of Germany’s main lay Catholic group, the Central Committee of German Catholics, Alois Glueck, welcomed the Vatican’s decision.
He said: “Pope Francis’s decision offers the chance of a first step toward a new beginning in the Limburg diocese, because the situation has become an increasing burden for the faithful there, and in all of Germany, over recent weeks.”
Bishop Franz-Peter Tebartz-van Elst – and his spending habits – had become infamous in Germany, where many people pay Church tax to the state. The tax raised 5.2 billion euros for Catholics and 4.6 billion euros for Protestants in 2012.
Calls were made for the bishop to resign after he was accused of lying under oath about his spending.
The bishop was criticized for a first-class flight to India to visit the poor.
But his official residence is at the heart of the criticism, after renovations were originally costed at 5.5 million euros.
German media are reporting that the residence was fitted with a bath that cost 15,000 euros, a conference table for 25,000 euros and a private chapel that cost 2.9 million euros.
The story has attracted heavy coverage and has stoked controversy among Catholics.
It was in Germany that Martin Luther launched the Reformation five centuries ago in response to what he said were excesses and abuses within the Church.
All this was bound to play badly with the new Pope, who has repeatedly expressed his disapproval of senior clerics whose lifestyles seem a little too lavish.
Pope Francis has also signaled his intention to clean up the Vatican’s finances, appointing a commission to advise him on reforms.
There is no surprise in Rome that the Vatican has ordered the bishop’s suspension from his duties while the spending row is investigated, our correspondent adds.
Steffen Seibert, a spokesman for German Chancellor Angela Merkel, who is the daughter of a Protestant pastor, said that she had expressed “hope that there will be an answer for believers, for people’s confidence in their Church”.
In Franz-Peter Tebartz-van Elst’s absence, the bishop’s diocese will be administered by Limburg’s vicar general, Wolfgang Roesch.
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