Penn, who had come out of retirement for the fight, promptly called it quits again.
Edgar (16-4-1) was too quick for a sluggish Penn, who had no answers in a lopsided battle of former champions before 6,500 at the Mandalay Bay Events Center. Penn (16-10-2) occupied the centre of the cage but did little while Edgar circled and attacked.
When Edgar took Penn down, he hurt him repeatedly.
Referee Herb Dean finally stopped the carnage at four minutes 16 seconds of the third round.
"Frankie did a great job," said Penn. "I shouldn't have come back. I shouldn't have been in the ring tonight."
And the 35-year-old Hawaiian said he's headed back to retirement.
"Of course, this is the end," an emotional Penn told the post-fight news conference after getting stitches. "I'm thinking to myself 'why did you step back in the Octagon after the beating that Rory MacDonald gave you (in December 2012)?' The reason is because I really needed to find out. If I didn't make this night happen for myself, I would have always wondered ... I guess I just needed some closure."
Despite the bloody loss, Penn said he would have regretted not fighting more.
UFC president Dana White didn't stick around to watch the whole fight.
"What more do you want, B.J.?" he told the post-fight news conference before Penn arrived. "There's nothing left to prove."
Penn, a baseball cap hiding the damage around his eyes, lowered his head to the table at one point when asked about his legacy. He was too emotional to speak.
White jumped in to fill the void.
"He's one of the best 155-pounders of all time," White said. "He built that weight class and he was responsible for helping build the UFC. That's his legacy."
Unlike the first two fights, which were held in the lightweight (155-pound) division, Penn and Edgar met this time as featherweights (145 pounds).
Edgar, who was a 4-1 favourite Sunday, took away Penn's lightweight title in 2010 and then beat him again in a rematch four months later. He later lost the 155-pound crown to Benson Henderson.
Penn, who also once held the welterweight title, last fought in late 2012 when he was beaten comprehensively by Canada's MacDonald in Seattle. He asked to come back to have another crack at the 32-year-old Edgar, with the UFC appointing them rival coaches on the reality TV show.
Edgar had gone 2-3-1 since their first two fights while Penn went 1-2-1 before retiring after the MacDonald loss.
Sunday marked Penn's 23rd fight in the UFC, fourth most in UFC history. It was Edgar's 16th trip to the Octagon.
A serene Penn ran out to cheers and the familiar Hawaiian strains of the late Israel Kamakawiwo'ole, although the music quickly morphed into an uptempo remix.
The lights dimmed and the pro-Penn crowd started booing. Edgar ran in to "Kick in the Door" by The Notorious B.I.G.
The fight started as the first two did. Edgar darted in and out while Penn looked — unsuccessfully — to connect.
Edgar scored an early takedown, alternating with launching kicks at the downed Penn and jumping back on top of him. Dean eventually let Penn get up, to cheers from the crowd.
It was more of the same in the second as Penn chased the speedy Edgar to little effect before being taken down. The round ended with Edgar scoring with heavy blows from above.
Penn's face was showing damage as the third round began. The Hawaiian tripped midway through the round, finding himself on his back again. An elbow opened Penn's face up as Edgar scored at will in a painful round to watch.
"I almost feel bad about it," Edgar said of the finish.
The card, coming on the heels of UFC 175 Saturday night, marked the finale to International Fight Week in Las Vegas.
The Season 19 finalists were all from Edgar's team, marking only the second time in TUF history that one team filled all four spots (Canada also did it in the "TUF Nations: Canada vs. Australia" series.
Middleweight Eddie (Truck) Gordon overpowered Dhiego Lima in 71 seconds to win the 185-pound Season 19 crown. Gordon (8-1) put Lima down with a pair of overhead rights at the fence and then landed a dozen more blows until Montreal referee Yves Lavigne stepped in.
The 30-year-old Gordon, who trains with UFC middleweight champion Chris Weidman, has a degree in finance, marketing and communication from Fordham University.
Lima (10-2), who fought five times in the Edmonton-based Maximum Fighting Championship, was competing one division above his normal welterweight class.
It was an almost exact replay in the 205-pound final as Corey (Beastin 25/8) Anderson hurt Matt (Gutter) Van Buren (7-3) early and often. The fight was stopped after just 61 seconds.
Anderson (5-0) has a degree in business administration from the University of Wisconsin-Whitewater and a liberal arts degree from Lincoln College.
Both winners earned a UFC contract and a Harley-Davidson motorcycle.
Coaches aside, Season 19 was seen as one of the more disappointing in the series' history. White admitted Saturday night that he tried not to think about it any more.
Saturday's fight was Penn's first at 145 pounds, adding another chapter that has seen him fight all over the weight map, including heavyweight.
He looked ripped at Friday's weigh-in — "awesome," according to White.
While an icon in the sport and one of only two fighters to win UFC championships in two different weight classes (Randy Couture was the other), Penn came into Sunday's card having won just one of his last six bouts.
Two of those losses were to Edgar. Also beaten by Nick Diaz, he defeated former welterweight champion Matt Hughes and fought Jon Fitch to a draw.
Canadians went 1-1 on the undercard.
Sarah (Cheesecake) Moras (4-1) of Kelowna, B.C., won her UFC debut with a 29-28, 29-28, 30-27 decision over Alexis (Sneaky Zebra) Dufresne (5-1) in a fight contested mainly on the ground.
Lightweight Jesse (The Body Snatcher) Ronson (13-5) lost a 29-28, 28-29, 30-27 decision to Kevin (The Motown Phenom) Lee, finishing on the wrong end of a split decision for the third UFC fight in a row.
Earlier on the main card, flyweight Dustin Ortiz won a 29-28, 28-29, 29-28 split decision over Justin (Tank) Scoggins (9-1), Ortiz (14-3) is ranked 13th among 125-pound contenders.
Heavyweight Derrick (The Black Beast) Lewis stopped American-based Brazilian Guto Inocente (6-3) with some nasty ground-and-pound in the first round. Then the 264-pound Lewis (11-2 with on no contest) somehow made it to the top of the fence to celebrate his second win in as many UFC fights.