In line with procedure, Davutoglu was to return to Erdogan the mandate he received from the president on July 9 to begin coalition talks with opposition parties, the official Anatolia news agency said.
Their closed-door meeting began at 1700 GMT at Erdogan's presidential palace in Ankara, NTV television said.
With all possibilities exhausted before a August 23 deadline to form the new government, Turkey is now facing snap new polls and entering uncharted political territory.
Davutoglu held coalition talks with the second-placed Republican People's Party (CHP) and third-placed Nationalist Movement Party (MHP) but failed to broker a deal with either.
According to the constitution, the AKP will be able to continue as a minority government until elections if a majority in parliament votes in favour of holding the early polls.
If however Erdogan uses his right to call the polls himself, a so-called "election government" will be formed until the polls, consisting of members from all four parties represented in parliament.
It will be the first time in Turkey's political history that the largest party has failed to form a coalition and repeat elections need to be held.
The AKP prides itself on providing Turkey with almost 13 years of stable one-party rule that have been a marked contrast to the chaotic coalitions and coups that marked political life before.
