In 1770 Tryon and his wife, Margaret Wake, moved into the Palace; at the time, "palace" was a standard word for any public building of this type. The construction of the house exacted great controversy in the North Carolina backcountry where most viewed it as an unnecessary, extravagant display of England. Extra taxation to fund the project had been levied by the governor on the citizens of the province, who had already felt overburdened with taxation. It proved to be too much and served as a major catalyst in North Carolina's War of the Regulation; which culminated in the Battle of Alamance on May 16, 1771, and later led to the hanging of seven men.

The unpopular Tryon left North Carolina on June 30, 1771, to become Governor of New York on July 8 of that year. He had only lived in the house a little more than a year. In May 1775, when the American Revolutionary War began, Governor Josiah Martin fled the mansion. Rebels seized the Palace and retained it as their seat of government. The new state's first general assemblies were held there and many of the furnishings were auctioned off to fund its administration.

North Carolina was admitted to the newly formed United States in 1789. Three years later, the North Carolina State House was built in Raleigh as the state capitol. Four state governors lived in the palace – Richard Caswell, Abner Nash, Alexander Martin, and U.S. Founding Father Richard Dobbs Spaight. The Palace was subsequently used for several different purposes, including a school, a boarding house, and a Masonic lodge. A cellar fire started in 1798, consuming the Palace proper.