The blaze broke out at the former North Wales Hospital, Denbigh, at 03:00 BST on Friday.
About 40 firefighters battled it overnight, with the roof collapsing.
North Wales fire service said it was working with police to investigate rumours children were seen climbing on the roof prior to the blaze.
A Denbighshire council spokesman said he was "shocked and appalled at the actions of those who have caused so much damage".
The former asylum, which closed in 1996, had been set alight a number of times, most recently in February.
There had been uncertainty over its future but following a long battle, Denbighshire council won a compulsory purchase order (CPO) and plans were announced last year to preserve it.
"The fire was contained within a wing of the main building.  Unfortunately, this is part of the building that was earmarked for restoration and re-development," the spokesman added.
"But because of the seriousness of the fire, the damage is beyond repair and will need to be demolished."
He said the local authority had been "pursuing every legal option" to preserve the site for many years and criticised "reckless behaviour which also puts lives at risk".
The council still intends to complete the CPO and pass the site to the North Wales Building Preservation Trust, which is formulating a business plan for it.
A fire service spokesman said the building was in "an unsafe condition" and staff would "remain on scene for some time in order to extinguish the fire".
Former nursing manager Clwyd Wynne said he is "sad, angry and disappointed" by the latest fire.
But he said it was not a surprise, because it has suffered "many fires, lots of vandalism" in the 21 years since the hospital closed.
"This [the fire] will hopefully get people to quicken the process [of starting work on the site] but I'm not confident," he added.
Part of a fire-ravaged Grade II-listed former hospital will need to be demolished because of the damage caused, Denbighshire council has said.