The rapper reacted to a jibe from the celebrity blogger after she started to aim Twitter abuse at DJ Baauer.
Banks posted a freestyle version of Baauer's track 'Harlem Shake', following the song's surge in popularity after a number of online viral videos.
However, the DJ was quick to criticise the rapper for offering a version of his track for free online just as it was starting to become popular.
Banks replied: "Why you c**kblockin tho??? Lmaoooo." The female artist later added that Baauer doesn't belong in hip-hop because he is a "p*ssy".
The war of words caused Hilton to intervene. He quipped: "How does it feel to be better known for all your trash-talking than your music, Azealia? #TeamBauuer (sic)"
Banks responded: "What does my p*ssy taste like perez?"
Continuing the argument, Hilton retaliated with: "It tastes like misguided youth, wasted talent, bitterness, jealousy and poo."
Banks then aimed a homophoic slur at Hilton, as seen below.
@perezhilton ugh... there you gooo, again faggot... trying to challenge and match my estrogen... YOU FUCKING WISH! HAA!— YUNG RAPUNXEL (@AZEALIABANKS) February 15, 2013
She later added: "all you want to do is destroy talented women..... because you're jealous hahahaahaha!!!!!!
"THEY NEED TO SACRIFICE PEREZ HILTON TO THE SUN GOD."
It is the second time Hilton and Banks have come to blows on Twitter, after the rapper used the word "f*ggot" as a slur last month.
Banks recently confirmed that her debut single 'Yung Rapunxel' has been delayed by her record label, but is expected to premiere next month.
Watch the music video for Azealia Banks's 'Liquorice' below: