The party leadership reversed course Tuesday and said they were nominating Nahles to run for election as chairwoman at a special party congress on April 22.
The party has been forced to act swiftly to fill the vacancy left by Schulz as it prepares for a make-or-break vote by the more than 460,000 members on whether to accept or reject the coalition deal with Chancellor Angela Merkel's conservative bloc.
Paul Ziemiak, leader of the conservatives' youth wing, welcomed Merkel's readiness to set out her picks for ministerial posts before a CDU party conference on February 26.
Just two days after the coalition deal was struck, Schulz announced he was abandoning his bid to serve as Germany's next foreign minister after heavy criticism from his party for seeking the job after he previously said he wouldn't serve in the next German government.
"I depart this office without bitterness or resentment", he said, nearly a year after he was elected as SPD party head with 100 percent of the vote.
The failure of SPD members to back the deal would likely spark a new election or force Mrs Merkel to attempt to rule at the head of a minority coalition.
GETTYMartin Schulz announces his resignation to party officials
"The window of opportunity is now, not in five or 10 years - maybe then it won't be there any more", he told party members in Vilshofen, Bavaria. In the meantime, deputy party leader and Hamburg Mayor Olaf Scholz would take over as interim leader, they said. The party's youth wing is already campaigning for a no-vote as it fears that another grand coalition with Mrs Merkel's conservatives will further erode the party's identity. Critics of the deal, led by Mr Kühnert, said that while Mrs Merkel remained chancellor, she would veto any SPD fiscal policies she didn't like.
The development followed Schulz's announcement Friday that he was abandoning plans to become foreign minister in the new government.
In a cartoon on Tuesday, the Sueddeutsche Zeitung daily showed Nahles with a whip riding an SPD snail. His supporters were also angered that the party would be working with an anti-immigration rival who was set to take control of the country's interior ministry. Media have speculated that one option might be Katarina Barley, a former SPD general secretary and family minister, or SPD veteran Thomas Oppermann.
Social Democratic Party leader Martin Schulz announced his resignation, DPA reported.
Among supporters of Merkel's Christian Democrats and their Bavarian sister party, the Christian Social Union (CSU) - with whom the SPD are poised to form a with coalition government - 71.6 percent were critical of the SPD's ability to govern.
The SPD originally wanted to reinvent itself in opposition but reconsidered when Merkel's attempt to form an alliance with two smaller parties failed late a year ago.