The seven-time European champions released Montella after a goalless draw against Torino on Sunday left them seventh in Serie A, 18 points behind leaders Napoli.
In 39-year-old Gattuso, the Chinese-owned club have turned to a member of one of their most successful sides, but he has little coaching pedigree.
Milan thanked Montella for his efforts and said in a statement: “Management of the first team is entrusted to Gennaro Gattuso.”
Gattuso made a total of 468 appearances for AC Milan between 1999 and 2012, winning a reputation as a rugged defensive midfielder and earning the nickname “Rino”, on account of his verbal raging and rampaging playing style.
He won the Serie A title twice and helped Milan to Champions League glory on two occasions.
Gattuso was such an integral part of Marcello Lippi’s line-up when Italy clinched the 2006 World Cup in Germany that he was named in FIFA’s team of the tournament.
AC Milan have not finished higher than sixth in any of the last four seasons in Serie A but new Chinese owner Li Yonghong funded a 230-million-euro ($270 million) signing spree in the summer.
Leonardo Bonucci arrived from Juventus for 38 million euros in an eye-catching move, while Portuguese player Andre Silva came for a similar sum from FC Porto and Hakan Calhanoglu was signed from Bayer Leverkusen.
But even with those reinforcements, Montella failed to put the club that was once the jewel in former Italian prime minister Silvio Berlusconi’s business empire in contention for a Champions League place. He leaves after 17 months at the San Siro.
– Slapped Ibrahimovic –
There will be heavy pressure on Gattuso, who has always had a controversial edge — he once slapped the then Ajax striker Zlatan Ibrahimovic with the back of his hand.
On another occasion that his temper spilled over, he infamously grabbed Tottenham assistant coach Joe Jordan — greying and 26 years Gattuso’s senior — by the throat before head-butting him, picking up a heavy UEFA ban.
Gattuso spent a season at Walter Smith’s Rangers before joining AC Milan and won the Scottish double alongside English midfielder Paul Gascoigne.
Since retiring as a player he has been working within the AC Milan structure as youth team coach after a stuttering coaching career elsewhere, with short stints at Sion in Switzerland, at Palermo and Pisa in Italy and at Greek minnows OFI Crete.
With Juventus now the main force in Italian football and Barcelona and Real Madrid dominating Europe in recent years, Gattuso faces a huge task to restore Milan to their former heights.
He was a key cog in the team featuring Paolo Maldini, Andrea Pirlo and Filippo Inzaghi which won the 2003 Champions League by beating Juventus on penalties.
He was on the losing side in the dramatic 2005 final in Istanbul when AC Milan blew a 3-0 lead to draw 3-3 with Liverpool and then lost in the penalty shootout, but he got his revenge two years later when Milan beat Liverpool in Athens.
He made 72 international appearances for Italy.
Milan also face a fight to convince UEFA that they comply with financial fairplay regulations designed to prevent clubs from overspending.
In order to meet the criteria, Milan are gambling on making a sharp increase in profits in China. For that, they need to qualify for the Champions League.
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