As the film begins, a title card opens the story, detailing its setting and historical backgrounds:
"It is almost one hundred years since Christian armies from Europe seized Jerusalem. Europe suffers in the grip of repression and poverty. Peasant and lord alike flee to the Holy Land in search of fortune or salvation. One Knight returns home in search of his son."
In a remote village in France in 1184, Balian (Orlando Bloom), a blacksmith and former warrior, is haunted by his wife's (Nathalie Cox) recent suicide after losing their unborn child. He is also shunned by nearly all of the villagers, except for the lord of the village, the lord Bishop, and his blacksmith apprentice. One day, a group of Crusaders arrive at the small village and one of them approaches Balian, introducing himself as his father, Baron Godfrey of Ibelin (Liam Neeson). Godfrey, asks Balian to return with him to Jerusalem. Balian refuses and the Crusaders leave. The town priest (Michael Sheen), Balian's younger and corrupt half-brother, attempts to claim Balian's property. To achieve this, he reveals that he had arranged for the Crusaders to come and take Balian away with them and ordered Balian's wife beheaded before burial (a customary practice in those times for people who committed suicide which would prevent them from ascending to Heaven), in an attempt to convince Balian to leave to the Holy Land. During the encounter, Balian, finally fed up with his half-brother and outraged by the revelation of the beheading of his late wife, kills him. It's also reveled throughout the film that Balian is a typically non-violent person, using violence to protect the innocent people and and in self-defense, but it was in that moment of the film where he had reached his breaking point and killed his half-brother out of rage for him and his decision to mutilate his dead wife's body. Balian, then, follows after his father in the hope of gaining forgiveness and redemption for him and his wife.
After he catches up to his father, Godfrey instructs him in swordsmanship. Then, soldiers sent by Godfrey's brother and led by Godfrey's nephew arrive to arrest Balian. Godfrey refuses to hand him over and during the subsequent fight most of Godfrey's men are killed and Godfrey himself is mortally wounded. It was revealed earlier in the film that Godfrey's brother and nephew plan to kill him and his men, in order to claim the title of Baron of Ibelin for themselves.
In Messina, Godfrey knights Balian and orders him to serve the King of Jerusalem and protect the helpless then succumbs to his injuries. On Balian's journey to Jerusalem, his ship is run aground by a storm, leaving Balian and a horse as the survivors of the wreck. When Balian releases the horse from the wreckage it flees in panic. Tracking the horse into the desert, Balian is confronted by a Muslim cavalier and his servant. A fight over possession of the horse follows and Balian slays the horseman, but spares the servant, asking him to guide him to Jerusalem. Upon their arrival in Jerusalem, Balian gives the horse to the servant and releases him. The man then tells him his slain master was an important knight amongst the Saracens.
After being accepted as the new Lord of Ibelin by Godfrey's retainers, Balian soon becomes acquainted with the main players in Jerusalem's political arena: the leper King Baldwin IV, Tiberias (Jeremy Irons), Marshall of Jerusalem, Princess Sibylla, King Baldwin IV's sister, and Guy de Lusignan (Marton Csokas), Sibylla's arrogant, prejudiced, and scheming husband, who supports the anti-Muslim activities. It is revealed is Sibylla is unhappily married to Guy, after having been made aware of his true nature. As a man who is obsessed with attaining glory and fortune for himself, it is implied that in his ruthless climb to prominence in the royal court and also to the throne of Jerusalem, Guy only married Sibylla for the purpose to be next in line to rule as King of Jerusalem, rather than for out of genuine love for her. He could even kill Siyblla's own son from her previous marriage in order to ensure that he would be King immediately and also in response to Siyblla doing something that would jeopardize his plans. He is determined to rule after Baldwin's death and seeks to provoke a war that will allow him to dispose of the Muslims and claim the Kingdom for the Christians.
As the new Baron of Ibelin, Balian settles in his new land of Ibelin. Using his skills as a blacksmith, he earns the respect of his knights and subjects by building an irrigation system. Sibylla travels to meet him, and the two become secret lovers.
Guy and his co-conspirator Raynald of Châtillon (Brendan Gleeson) massacre a Muslim trade caravan with the aid of the Templars. Saladin, leader of the Muslim forces attacks Kerak, Raynald's castle, to bring him to account for his crime. Balian decides to protect the villagers as they attempt to enter the castle from Saladin's cavalry. Though outnumbered, Balian and his knights charge Saladin's cavalry, allowing the villagers time to flee to the castle; Balian's knights are soon defeated resulting in their capture. In the enemy camp, Balian encounters the 'servant' he freed, Imad ad-Din, learning he is actually Saladin's Chancellor, who then releases Balian to enter Kerak. Saladin arrives with his army to besiege Kerak and King Baldwin IV approaches with his. The two rulers successfully negotiate a Muslim retreat and Baldwin swears that he will punish Raynald for his crimes. The exertion of these events cause Baldwin to collapse, weakened beyond recovery.
Baldwin asks Balian to marry Sybilla (Eva Green), knowing that the pair have affection for each other, but Balian refuses to be associated with the necessary murder of Guy. After Baldwin dies, Sibylla's six-year-old son Baldwin V becomes King of Jerusalem. It quickly becomes apparent that he is also infected with leprosy. Grief-stricken and unwilling to condemn her son to a life behind a mask, Sibylla gives him poison. Sibylla succeeds her son and names Guy King of Jerusalem. Guy releases Raynald asking him to give him a war, which Raynald does by murdering Saladin's sister. When Saladin sends an emissary to demand the return of his sister's body, the heads of those responsible, and the surrender of Jerusalem, Guy answers by decapitating the emissary and sending his head back to Damascus.
In 1187, council war is agreed upon "because God wills it" and against sound advice they march into the desert away from adequate water supplies to fight Saladin, leaving Jerusalem unguarded except for Balian, his knights, and the townspeople. Saladin's army attacks the Crusader army near to the city of Hattin, and at the Battle of Hattin, the Crusader army is annihilated. Guy and Raynald are captured; Saladin executes Raynald, and then marches on Jerusalem, sparing Guy out of tradition but stating that he is not worthy of this.
Back at Jerusalem, Balian prepares the defenses, challenging the Patriarch's advice to flee, and then knights a number of men-at-arms because "making a man a knight makes him a better fighter." Knowing they cannot defeat the Saracens, they hope hold their enemies off long enough for the Saracens to offer terms and, in the process, remaining true to himself and showing the example of his late father, Godfrey, inspires the people within the city with the importance of consciousness, humanity, heroism, inclusion of people outside of their Christian faith, performing acts of goodness that God desires for them to do, and the ideal of being anything they want to be that others denied them of before. After three days and having proven their resolve, Saladin offers terms: Balian surrenders Jerusalem when Saladin offers all the inhabitants safe passage to Christian lands. Balian points out that when the Crusaders conquered Jerusalem a hundred years previously, they massacred the Muslim inhabitants, but Saladin assures him that he is "not those men". After considering his terms and reflecting on everything that had happened, he surrendered Jerusalem to Saladin. As the two begin to return back to their respective sides, Balian stops and asks Saladin, "What is Jerusalem worth?" He stops, replies "Nothing", and returned walking back to the Muslims. His comment meant that Jerusalem as a city is worth "nothing". As Saladin continues walking back, he stops again, looks at Balian, and delivers his second answer, "Everything." His second answer meant that he believes that Jerusalem is worth "everything" to everyone, where, although they may belong to a different religious faith, they are bound together their shared faith and devotion to God and can live together in peace and harmony as friends or as a family. Satisfied with his answers, Balian returns back to Jerusalem.
As he returns to the city, Balian tells the inhabitants Saladin's terms and that all will be safely escorted to the sea. Furthermore, he says "if this is the kingdom of Heaven, let God do with it what He will". The people inside the city cheered and celebrated for Balian and the promise of living a kingdom of Heaven anywhere they go with anyone they'll meet, Christian or no. Afterwards, Balian encounters Sybilla and tells her that her brother's kingdom was in his head and his heart (reflecting back to the moral teachings of her brother and the Knight Hospitaller), which can never be surrendered and lost. Sybilla asks him what she'll do now, since that she is still the Queen of several cities outside of Jerusalem. Balian suggests for her to renounce her claim as Queen and if she does, he will come for her and they'll go away together.
As the Christians were getting ready to leave the city, the disgraced and humiliated Guy, after having been released by Saladin, confronts Balian one last time and challenges him to a fight. Balian defeats and ultimately spares him. Defeated, Guy, now with nothing left to lose, begs Balian to kill him. He ultimately spares him and said: "When you rise again... if you rise... rise a knight." As the Christians leave the city, Balian bids farewell to his Christian and Muslim friends. Imad returns the horse to Balian, saying it was not a good horse anyway and asks him if God didn't love Balian, how could he have accomplished so much. They wish each other peace in the other's language. While Balian said his farewells to his friends, Saladin and the Muslims settle in their new home. Saladin's forces destroy many of the Christian books and replace the cross on the top of the church with a crescent. Privately, Saladin is shown refusing to step on the stones carved with crucifixes, and later picks up a cross and gently puts it back on a table.
In the marching column of Christian citizens, Balian finds Sibylla, who has renounced her claim as Queen of Jerusalem and other cities and also has officially separated from Guy. They hold each other's hands, as they smile at each other and walking towards to the sea.
Balian returns back to his village in France. As he walks around his house, he reflects on how much time has passed by and how much he is now a reborn man. Then, a column of English knights ride through the village, looking for Balian, whose legendary reputation has spread throughout Europe as the defender of Jerusalem. Balian replies that he is the blacksmith, and the man identifies himself as King Richard I of England, and they are commencing a new Crusade to retake Jerusalem from Saladin. Balian responds that he is still the blacksmith and Richard and his knights rides off. Balian is joined by Sybilla, and passing by the grave of Balian's wife, they leave the village for good and ride towards a new life together.
An epilogue states the following: "The King, Richard the Lionheart, went on to the Holy Land and crusaded for three years. His struggle to regain Jerusalem ended in an uneasy true with Saladin. Nearly a thousand years later, peace in the Kingdom of Heaven remains elusive."