The quality of an item in the world of Terraria is determined by the color of its name. There are currently fourteen tiers of item quality.
Tier -11: Amber (Quest Fish)
This special tier contains only "quest items" to be turned over to quest-giving NPCs for rewards. Quest items can only be obtained while on a quest, and are worthless otherwise.
Tier -1: Gray (Poor)
Tier 0 or Tier 1 items that have labels such as "Shameful" "Weak" "Annoying" or "Broken" after being crafted or reforged will become gray.
Tier 0: White (Common)
Most items in the game that are craftable will end up being Tier 0. The Copper Helmet is an example of a Tier 0 item. With the exceptions of Obsidian, Fireblossom and Fireblossom Seeds, items of this tier are destroyed when in lava that is deep enough to cover approximately 25% of the item.
Tier 1: Blue (Good)
Weapons and Armor made of Demonite or better are Tier 1. Certain accessories such as Lucky Horseshoes are also tier one. Certain uncraftable weapons are Tier 1 such as the Ball O' Hurt.
Tier 2: Green (Uncommon)
Tier 2 items are largely uncraftable, with the exception of Necro Armor and the Star Cannon. Muramasa as well as certain spells like Water Bolt are Tier 2. There are many items in Avalon that are rarity 2, and most of them are craftable with the exception of the Dungeon weapon additions.
Tier 3: Orange (Rare)
Weapons and armor made of Hellstone are Tier 3. Certain uncraftable weapons are Tier 3, such as the Staff of Regrowth. These items are generally rare and high end items, except for the Staff of Regrowth, which generally is only used for cosmetic purposes. Feral Claws and the Flower of Fire are Tier 3. These items are rare and usually found later in the game.
Tier 4: Red (Epic)
Most items made of Cobalt, Mythril, or Adamantite bars in the 1.1 update are naturally Tier 4.
Tier 5: Magenta (Legendary)
When a Tier 4 Item is crafted with labels such as "Violent" or "Godly." An example of a Tier 5 item would be a no-prefix Excalibur. A strong weapon like this is automatically put in a higher tier in comparison to a weaker item.
Tier 6: Purple (Ultimate)
This quality is on late game items such as anything in the Hallowed Set, and some items with top-tier effects, such as "Legendary", "Mythical" and "Unreal". This can be achieved by reforging items or looting chests. This does not apply to all top-tier forged items. This was the former highest tier that could be achieved in Terraria 1.1.2.
Tier 7: Lime Green (Awesome)
Items acquired around Plantera, Golem, and the Hardmode Underground Jungle. Chlorophyte tools and weapons, Ankh Shield, Temple Key, and some Frost Moon drops are Tier 7.
Tier 8: Yellow (Supreme)
Late post-Plantera items, including those acquired from the post-Plantera Dungeon. Biome Chest items, Frost Moon and Pumpkin Moon drops, Duke Fishron drops, Shroomite, Beetle, and Spectre armor sets, Spectre tool set, the Terra Blade, and all Mounts except for the Minecart are Tier 8.
Tier 9: Cyan (Developer)
This tier is primarily for Lime and Yellow items that have high-level modifiers. Obtainable items generally do not have this as a base rarity, but the unobtainable developer-reserved items do*. This is the highest tier in vanilla 188.8.131.52.
*Obtainable as of vanilla Terraria 184.108.40.206.
Tier 10: Dark Red (Extreme)
This tier is only for some Superhardmode items, including the armor sets and the Soul of Torture.
Tier 11: Dark Purple (Extremely Supreme)
The only items that are tier 11 by default are the Underworld Key Mold, Underworld Key, and the Hellrazer. This tier can only be obtained on other items by having prefixes.
Tier 12: Rainbow (Oh my god!)
Rainbow items are extremely rare items in the source mod. The only vanilla item with rainbow "rarity" is the Rainbow brick, but its name is colored rainbow in the menu simply because it matches the color of the block, and has nothing to do with the rarity.
Like other endgame categories, the Rainbow rarity is usually achieved with a good prefix on a previous-tier rarity, in this case Dark Purple. Examples of items with Rainbow rarity are: Most good prefixes on a Hellrazer, great prefixes on a Tritanorium Sword, and Opal.