Analysts heralded the start of what could be a bloody end game, as hundreds of thousands of opposition supporters poured on to the streets of Tehran and other cities and fought running battles with the security forces.
Opposition websites claimed some policemen had refused to fire on demonstrators.
Foreign journalists have been banned from Iran but Western newsrooms were inundated with mobile phone film of astonishing scenes as demonstrators fought riot police and the Republican Guard's feared Basiji militia. A leading opposition activist claimed: "The entire country is beginning to rise."
The violence came a week after the death of dissident cleric Hussein Ali Montazeri, an inspiration to Iran reformists and a fierce critic of the clerical regime he helped to create.
The violence flared on a major religious holiday, Ashura. An Iranian opposition leader condemned the killing of protesters during Shia Islam's most important observance.
Mahdi Karroubi, a candidate who lost in June's disputed presidential election won by President Mahmoud Ahmadinejad, said even the former shah's regime respected the holy day of Ashura.
Ashura is the culmination of a 10-day commemoration of a revered seventh-century Shia saint, Imam Hossein, who was killed fighting injustice. The deaths could become heavy with symbolism in Iran, given that Islam bans fighting during this season. During its war with Iraq, Iran halted its attacks during this time and during Iran's 1970s Islamic revolution, protesters came out en masse against the shah on that day, assuming correctly that he wouldn't attack.
"Killing people on Ashura takes this crisis to a whole other level," said Roozbeh Mir Ebrahimi, a political analyst and journalist.
Analysts yesterday said that if public outrage over the violence aligns the so-far dormant religious class against Supreme Leader Ali Khamenei, the crackdown could prove to be a milestone.
Opposition websites said that demonstrators broke through cordons, blocked streets to thwart squads of baton-wielding motorbike police, hurled stones, stripped captured police officers of their uniforms and weapons and burned state-owned banks.
Mobile telephone footage showed them holding aloft captured Basiji crash helmets as onlookers cheered. Film clips showed demonstrators trying to tear down Ayatollah Khamenei's portrait and trampling on a street sign bearing his name.
The protester deaths were the first shootings of demonstrators since June 20, eight days after the disputed election. The opposition website Rahesabz said security forces opened fire on a crowd near Enghelab Square in Tehran after failing to disperse it with teargas, baton charges and warning shots.
It was reported that Seyed Ali Mousavi, 35, the opposition leader's nephew, was shot near Enghelab Square. Reports last night said he appeared to have been assassinated in a political gesture aimed at his uncle.
Mr Mousavi was said to have been run over by a 4WD vehicle outside his home, then shot. Government officials took the body and warned the family not to hold a funeral. His family said last night the body had been transferred without its knowledge to an unknown location.
"We cannot find it," said Seyed Reza Mousavi. "Nobody accepts responsibility for taking away the body . . . We cannot have a funeral before we find the body."
The White House strongly condemned what it called the suppression of civilians in Iran.