The Australian 19th seed was due to face Roman Safiullin on Tuesday but opted out on Monday. He will be replaced by lucky loser Denis Kudla.
Kyrgios had undergone a routine MRI on his knee which revealed a cyst as a result of a small lateral meniscus tear, forcing him out of the opening major of the year. The 27-year-old will undergo an arthroscopic surgery to heal the knee injury.
"Bad timing. Injuries are part of the sport," Kyrgios told reporters. "I'm devastated obviously, it's my home slam.
"It's pretty brutal. One of the most important tournaments of my career, so it hasn’t been easy at all."
Kyrgios, who pulled out of the United Cup late last month citing exhaustion, had played Novak Djokovic in an exhibition match on Friday.
The Australian started to feel some discomfort in his knee during that match, before making the decision to pull out on Monday.
"I wanted to give myself hope, I thought I had a chance," he said.
The 2022 Wimbledon finalist had been placed in the same section of the draw as nine-time Australian Open champion Djokovic along with Andrey Rublev and Holger Rune.
Kyrgios was the highest-ranked local player in the men's and women's singles draws, with 22nd seed Alex de Minaur the next best Australian hope.
Reigning women's singles champion Ash Barty retired last year, while compatriot Ajla Tomljanovic, ranked 35th in the world, withdrew due to an ongoing knee issue on the weekend.