Detailed proposals for the new Royal Edinburgh Hospital are due to be discussed by councillors at Edinburgh City Council's planning committee next month.
If the plans get the go ahead, construction at the Morningside site should begin within months and work is expected to be completed at the end of 2016.
The new network of buildings - which will be the first phase of a bigger development - will include a main inpatient unit for people with acute psychiatric problems, and two smaller units - one for older people with mental health problems and one for people who have suffered a brain injury.
Originally the Edinburgh Lunatic Asylum, the hospital opened in 1813. It was renamed The Royal Edinburgh Hospital for Mental and Nervous Disorders in 1922. The hospital's original building, MacKinnon House, which is listed architecturally will be refurbished in a later phase. Most of the other existing buildings will be demolished.
Concerns have been raised, however, over a reduction in the number of beds from 256 to 185, with the British Medical Association (Scotland) saying there could be a need for more beds rather than fewer as the population ages. However, the health board says it has taken this issue into account and as well as providing care the new facility will also be expanding its community services.
Problems with the existing buildings were highlighted in the application going to planners and included being unsuitable for patient care, leading to a greater risk of serious incidents on the wards. The buildings are also described as costly to run and a poor environment to work in.
The application said: "The older buildings on the site... are in part unsuitable for treatment of mental illness due to their complicated layouts, poor sightlines, high maintenance and heating costs and limited or poor standard of residential accommodation. The condition of the buildings poses significant challenges to provide the quality of care and working environment required.
"Poor or inappropriate accommodation can also have a profound effect on patient wellbeing, staff recruitment and retention and the number and severity of incidents on inpatients wards."
It says problems with existing facilities are such that the set up is not financially sustainable: "It is proposed that the majority of buildings or structures on the site will ultimately be demolished over the life time of the plan to make way for the construction of new, high quality, fit-for-purpose facilities."
In an interview with The Herald earlier this month Dr Donald Lyons, chief executive of the watchdog, the Mental Welfare Commission of Scotland, criticised the standard of accommodation at the Royal Edinburgh Hospital, as "outdated" and "shameful".
He welcomed plans for the new hospital, adding that he accepted the reduction in bed numbers as long as there were sufficient community services to support patients.
"As I understand it, NHS Lothian wants to take the rehab facilities off site to be community based. What you have is a rehabilitation centre, not in the hospital, but in the community. I believe that does help people recover from their illness and reintegrate into the community much better than a facility based in the hospital," he added.
David Small, chairman of the Royal Edinburgh Hospital Project Board at NHS Lothian, said the new facility would work alongside a growing number of community-based services.
"The Royal Edinburgh Hospital campus development is a hugely exciting project which, once completed, will bring many benefits to both patients and staff and to surrounding communities.
"Our plans for mental health beds are in line with our longer term mental health strategy which includes providing more care for patients in the community and less in hospital beds. Patients and families tell us that they prefer to be cared for at home and this aids rehabilitation and recovery," he said.
"Phase one of the development will have 185 beds and we are currently looking at the mix of those beds between services, as well as considering the number of services that will be included in future phases of the development. Our senior clinical staff, as well as patients and partner representatives through our stakeholder group support us in this move.
"We have already invested significantly in community mental health and rehabilitation services such as intensive home treatment teams, crisis intervention services like the Edinburgh Crisis Centre and in 24/7 supported accommodation in the community."