Prosecutors on Thursday applied in a Children's Court to withdraw the charge against the girl but did not give a reason why.
The magistrate withdrew and struck out the charge of murder.
She is not facing any other offences after police also withdrew charges from another two separate matters.
The girl, who cannot be identified for legal reasons, did not appear in court in person or via video link on Thursday.
Neighbours found the woman's body on the flat's bathroom floor, naked and covered in stab wounds. (Diego Fedele/AAP PHOTOS)
A Victoria Police spokeswoman said the murder charge was withdrawn following significant consideration and advice from the Director of Public Prosecutions.
"It was the director's position that there were not reasonable prospects of conviction in this matter because the prosecution would not have been able to rebut the presumption of doli incapax," the statement read.
Doli incapax is the presumption that a child aged under 13 is incapable of understanding the wrongfulness of their actions and therefore cannot be convicted of a crime.
The 12-year-old girl was being assessed by a psychiatrist in relation to doli incapax.
She was accused of fatally stabbing a 37-year-old woman at a Footscray apartment on November 16, 2023.
The court was told detectives arrived to find blood all over the apartment's kitchen floor and bathroom, with the girl and two neighbours waiting in the hallway.
The neighbours had called triple zero after being woken up about 1.30am by a noise and finding the 12-year-old crying in the hallway.
The girl told one of the neighbours the woman had killed herself and she had tried to drag her into the shower.
The neighbours entered the apartment and found the woman's lifeless body on the bathroom floor, naked and covered in stab wounds.
A knife was allegedly found in the victim's hand, with a pair of bloodied white sneakers next to the body.
The shoes and knife, along with fake nails, condoms, deodorant cans and clothing, were seized by police.
Prosecutors applied for a magistrate to allow them to take DNA from the girl to match against the fingernails and shoes.
The magistrate flagged issues around the child's mental capacity to consent to giving DNA due her intellectual disability and because she is estimated to have the maturity of someone half her age.
Prosecutors withdrew the DNA application on Thursday, along with the murder charge.
Victoria Police confirmed the 37-year-old woman's death had been referred to the coroner.
"The family of the victim has been notified and we will continue to support them throughout this process," the spokeswoman said.
"Our thoughts are with them today."
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