The attackers entered the church in Saint-Etienne-du-Rouvray during Mass, taking the priest, Fr Jacques Hamel, 84, and four other people hostage.
Police later surrounded the church and French TV said shots were fired. Both hostage-takers are now dead.
The Amaq news agency, linked to so-called Islamic State, said "two IS soldiers" had carried out the attack.
President Francois Hollande said the men had claimed to be from IS.
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French interior ministry spokesman, Pierre-Henri Brandet, said one of the hostages had been critically wounded.
He said the hostage-takers had been "neutralised" after coming out of the church. French prosecutors say one person has since been detained over the attack.
Police sources said it appeared the attackers had slit the priest's throat with a knife.
The area was cordoned off while the church was searched for explosives, and police told people to stay away.