Hoy will instead focus on the keirin, in which he won the world title earlier this year, and then join forces with Kenny in the team sprint.
"Whilst I’m obviously disappointed not to be defending all three of my 2008 Olympic titles in London, Jason thoroughly deserves this opportunity and has a great chance of success in the sprint," Hoy said.
"I’m now focussed entirely on the keirin and team sprint and my goals for these two events haven’t changed."
Choosing between Hoy and Kenny had caused selectors plenty of grief, with both seeming to have equal claims on getting the nod.
Four years ago they won gold and silver in Beijing but rules were changed to allow only one rider per nation for these Games.
The four-time Olympic champion shone at the test event in London earlier this year but former world champion Kenny won silver at the World Championships in Melbourne.
"We have now finalised our selection for the track events and in particular we have made the decision over who will ride the sprint," said British Cycling's performance director Dave Brailsford.
"Both Chris and Jason are on great form and that made it a difficult choice but we have decided to select Jason to contest the sprint and Chris will concentrate on the keirin.
"We believe this gives us the strongest team possible going into the Games."
Elsewhere, it was confirmed Phillip Hindes would complete the team sprint squad with Ross Edgar named as reserve.
Victoria Pendleton will go for gold in three events - the sprint, keirin and team sprint, with Jess Varnish.
Meanwhile, as expected, Ed Clancy and new world champion Laura Trott will compete in the omnium.