The 27-year-old, whose 35 goals for the Posh last season helped the club achieve promotion to the Championship via the play-offs, rejected offers from West Ham United and Leicester City.
But the forward has opted to move to the south-coast, to the delight of manager Gus Poyet.
"When I first sat down with the chairman, Craig was at the top of my list, our number one target, so I am absolutely delighted to have signed him," he said.
"He is going to be a key player for us. He was the best player in League One last year, he scored the most goals, he scored in the play-off final, and he's got everything we need to help make our strikeforce one of the best.
"He is a player that we can build our team around, which is why I was so keen to bring him here, and one of the most pleasing aspects for me is that we have signed him despite interest from some other big, big teams."
Mackail-Smith's form last season saw him win his first international cap for Scotland in the friendly against Brazil in March and he joins the Seagulls having scored 80 goals in 185 league appearances.
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