Karen Dinesen was the daughter of writer and army officer Wilhelm Dinesen and Ingeborg Westenholz, and the sister of Thomas Dinesen. She was born into a Unitarian bourgeois family in Rungsted, on the island of Zealand, in Denmark, and she was schooled in art in Copenhagen, Paris, and Rome.

She began publishing fiction in various Danish periodicals in 1905 under the pseudonym Osceola, the name of the Seminole leader, possibly inspired by her father's connection with Native Americans. From August 1872 to December 1873, Wilhelm Dinesen had lived among the Chippewa Indians, in Wisconsin, where he fathered a daughter, who was born after his return to Denmark. Wilhelm Dinesen hanged himself in 1895 after being diagnosed with syphilis when Karen was nine.

In 1913 Karen Dinesen became engaged to her second-cousin, the Swedish Baron Bror von Blixen-Finecke, after a failed love affair with his brother. The couple moved to Kenya, where in early 1914 they used family money to establish a coffee plantation, hiring African workers, predominantly the Kikuyu tribespeople who lived on the farmlands at the time of their arrival.
The two were quite different in education and temperament, and Bror Blixen was unfaithful to his wife. She was diagnosed with syphilis toward the end of their first year of marriage, which although eventually cured (some uncertainty exists), created medical anguish for years afterwards. The Blixens separated in 1921 and were divorced in 1925.

During her early years in Kenya Karen Blixen met the English big game hunter Denys Finch Hatton, and after her separation she and Finch Hatton developed a close friendship which eventually became a long-term love affair. Finch Hatton used Blixen's farmhouse as a home base between 1926 and 1931, when he wasn't leading one of his clients on safari. He died in the crash of his de Havilland Gipsy Moth biplane in 1931. At the same time, the failure of the coffee plantation, due to the worldwide economic depression and the unsuitability of her farm's soil for coffee growing, forced Blixen to abandon her beloved farm. The family corporation sold the land to a residential developer, and Blixen returned to Denmark, where she lived for the rest of her life.

On returning to Denmark, Blixen began writing in earnest. Her first book, Seven Gothic Tales, was published in the US in 1934 under the pseudonym Isak Dinesen. This first book, highly enigmatic and more metaphoric than Gothic, won great recognition, and publication of the book in the UK and Denmark followed. Her second book, now the best known of her works, was Out of Africa, published in 1937, and its success firmly established her reputation as an author. She was awarded the Tagea Brandt Rejselegat (a Danish prize for women in the arts or academic life) in 1939. During World War II, when Denmark was occupied by the Germans, Blixen started her only full-length novel, the introspective tale The Angelic Avengers, under another pseudonym, Pierre Andrezel; it was published in 1944. The horrors experienced by the young heroines were interpreted as an allegory of Nazism. Her writing during most of the 1940s and 1950s consisted of tales in the storytelling tradition. The most famous is Babette's Feast, about a chef who spends her entire ten-thousand-franc lottery prize to prepare a final, spectacular gourmet meal. The Immortal Story, in which an elderly man tries to buy youth, was adapted to the screen in 1968 by Orson Welles, a great admirer of Blixen's work and life. Welles later attempted to film The Dreamers, but only a few scenes were ever completed.

Blixen's tales follow a traditional style of storytelling, and most take place against the background of the 19th century or earlier periods. Concerning her deliberately old-fashioned style, Blixen mentioned in several interviews that she wanted to express a spirit that no longer exists in modern times, that of destiny and courage. Indeed, many of her ideas can be traced back to those of Romanticism. Blixen’s concept of the art of the story is perhaps most directly expressed in the story "Cardinal’s First Tale" from her fifth book, Last Tales.

Though Danish, Blixen wrote her books in English and then translated her work into her native tongue. Critics describe her English as having unusual beauty, great skill, and precision. Her later books usually appeared simultaneously in both Danish and English. As an author, she kept her public image as a charismatic, mysterious old Baroness with an insightful third eye, and established herself as an inspiring figure in Danish culture, although shunning the mainstream.

Blixen was widely respected by contemporaries such as Ernest Hemingway and Truman Capote, and during her tour of the United States in 1959, the list of writers who paid her visits included Arthur Miller, E. E. Cummings, and Pearl Buck. She also met actress Marilyn Monroe in 1959. She was admired by the patron Pauline de Rothschild of the Rothschild family.

Although it was widely believed that syphilis continued to plague Blixen throughout her lifetime, extensive tests were unable to reveal evidence of syphilis in her system after 1925. Her writing prowess suggests that she did not suffer from the mental degeneration of late stages of syphilis, nor from cerebral poisoning due to mercury treatments. She did suffer a mild permanent loss of sensation in her legs that could be attributed to chronic use of arsenic in Africa. Others attribute her weight loss and eventual death to anorexia nervosa. During the 1950s Blixen's health quickly deteriorated, and in 1955 she had a third of her stomach removed due to an ulcer. Writing became impossible, although she did several radio broadcasts. In her letters from Africa and later during her life in Denmark, Karen Blixen wondered if her pain was psychosomatic. Publicly she blamed her trouble on syphilis—a disease that afflicted heroes and poets, as well as her own father. Whatever her belief about her illness, the disease suited the artist's design for creating her own personal legend.

Unable to eat, Blixen died in 1962 at Rungstedlund, her family's estate, at the age of 77, apparently of malnutrition. The source of her abdominal problems remains unknown, although gastric syphilis, manifested by gastric ulcers during secondary and tertiary syphilis, was well-known prior to the advent of modern antibiotics.

Blixen lived most of her life at the family estate Rungstedlund, which was acquired by her father in 1879. The property is located in Rungsted, 24 kilometers (15 miles) north of Copenhagen, Denmark's capital. The oldest parts of the estate date back to 1680, and it had been operated both as an inn and as a farm. Most of Blixen's writing took place in Ewald's Room, named after author Johannes Ewald. The property is managed by the Rungstedlund Foundation, founded by Blixen and her siblings. The property opened to the public as a museum in 1991.