He complained that the National Council - whose 36 members have been appointed by the United Nations - no longer reflected the views of East Timorese people.
East Timor has been under a UN administration since 1999, following an independence vote from Indonesia which invaded the former Portuguese colony in 1975.
It is set to hold elections in August, after which a new constitution will be drawn up.
Mr Gusmao - who led the East Timorese resistance to Indonesian forces for years - was widely expected to become East Timor’s first president.
He once faced life imprisonment over his separatist struggle and spent six years in an Indonesian prison. After his liberty, he vowed to bring peace to his homeland.
According to the Portuguese news agency, Lusa, Mr Gusmao resigned after a heated debate in the National Council over the shape of a new constitution.
Mr Gusmao was also reportedly angry that his own party, Fretilin, blocked a proposal that all of East Timor’s 600,000 people be canvassed for their views.
“I feel, as president of the National Council, that any attempt to overcome the deadlock is in vain due to the lack of willingness [of Council] members,” he said in a resignation letter to the UN transitional authority in East Timor (UNTAET).
“As I refuse to be part of a politically irresponsible process, I hereby tender my resignation,” he said.
Mr Gusmao has resigned before over political disputes.
Last August, he resigned from the territory’s main political coalition, the National Council of Timorese Resistance. But he withdrew his resignation later that day, saying he underestimated the strength of his popular support.
Mr Gusmao has received the European Parliament’s
prestigious Sakharov human-rights prize.