Germany's Der Spiegel news magazine and Süddeutsche Zeitung daily newspaper published video Friday of Strache appearing to offer government contracts to a woman who claimed to be a Russian investor and niece of an oligarch.
Kurz said at a news conference in Vienna that the FPÖ "damages the reputation of our country," announcing that he had recommended the President schedule new elections as soon as possible.
The call for early elections signaled the end of the ruling coalition of Kurz's conservative People's Party (ÖVP) with the FPÖ.
During a news conference Saturday morning, Strache denied doing "anything against the law," and labeled the allegations "a targeted political attack."
However, Strache said he wanted to "apologize to everyone I have disappointed with my behavior." He said he would also step down as head of the Freedom Party.
The scandal is the biggest crisis the coalition has faced since it was formed in 2017. Outside the chancellor's office in Vienna, more than 5,000 protesters gathered, calling for fresh elections.
"I'm here's because Strache resigned and the entire FPÖ is intolerable," Florian Gantner told CNN. "The chancellor has to react and the entire government should step down. We need a new election."
The managing director of Austria's Social Democratic Party (SPÖ) blamed Kurz for the scandal.
"He must confess to the Austrians this failure and take full responsibility for this chaos. He has brought Austria into this disastrous situation and put the stability of the country on the line," SPÖ's Thomas Drozda said in a statement.
It is not known who recorded the video or set up the meeting, which allegedly took place July 24, 2017, on the Spanish island of Ibiza, three months before the Austrian elections.
Der Spiegel and Süddeutsche Zeitung report that the "Russian" woman offered to buy a 50% stake in Austria's Kronen Zeitung newspaper and ensure it supported the Freedom Party.
Strache admitted to meeting the woman and described it as a "private conversation" in Ibiza. He said he was "drunk" but "no donations have been made to the party" as a result of the meeting.
"It was a typical alcohol-infused macho behavior. ... With this I have hurt the most important person in my life, which is my wife," Strache said.
Kurz had accepted his resignation, Strache said. Transport Minister Norbert Hofer, who ran for president in 2016, is expected to take over from him as head of the Freedom Party.
Kurz said Strache's tactics exposed in the "despicable" video "damages the reputation of our country."
Austrian President Alexander Van der Bellen said the only way forward was with "fresh elections. "These are shameful images," he said referring to the video. "Nobody should have to be ashamed of Austria.
"Austrians have the right to have a government they can trust, a government that is esteemed and respected in Europe and the entire world," he added.
Freedom Party politician Johann Gudenus, who was in the video translating Russian into German for Strache, also resigned Saturday.
"With this I announce that I will retire from my position as managing club chairman and as member of parliament. I will step back from all my positions within the Freedom Party of Austria," Gudenus said in a statement.
"I want to express my deep regret for the things that happened more than two years ago. I deeply regret having disappointed the trust from voters, party members and co-workers."
Controversial coalition
The Freedom Party has long been part of Austria's political landscape. Founded by former Nazis in the 1950s, it first entered government 17 years ago, the first far-right party to do so in postwar Europe.
Strache had sought to modernize the party, but accusations of anti-Semitism and Islamophobia continue to linger.
In April, a Freedom Party member and deputy mayor of Hitler's birthplace resigned after writing a "deeply racist" poem comparing migrants to rats.
According to Reuters, the Freedom Party has a cooperation agreement with Putin's United Russia party.
Strache is an opponent of sanctions on Russia, which were imposed by the European Union and the United States over Russia's annexation of the Black Sea peninsula of Crimea in 2014.
In a 2018 interview with the newspaper Oesterreich, Strache made his position clear.
"It is high time to put an end to these exasperating sanctions and normalize political and economic relations with Russia," he said.
Austria was also one of the few EU countries not to expel Russian diplomats in response to British allegations of Kremlin involvement in the poisoning of a former Russian spy and his daughter in the English city of Salisbury in March 2018.
An earlier version of this story used an incorrect acronym for the People's Party and misspelled the name of the Austrian President. This has been corrected.
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