The club president Florentino Pérez held a press conference on Monday in the Spanish capital, where it was announced that the 55-year-old Italian is to leave with immediate effect.
Ancelotti, who joined Real from Paris Saint-Germain in June 2013, won the Champions League, Copa del Rey, Uefa Super Cup and the Fifa Club World Cup in his first season in charge. But after being eliminated from the Champions League at the semi-final stage by Juventus and failing to win La Liga for the first time since 2011/12, it is understood the former Chelsea manager was informed of his fate in a meeting on Monday.
"Carlo is part of our history because he won the Décima for us," said Pérez.
"But here the demands are very high and we need to give Real Madrid a new push that allows us to reach the level that we want to be.
"It was a very difficult decision to make; the demands at this club are the utmost because Madrid always wants to win silverware.
"The affection that the players and the fans have for Carlo is the same as the affection I myself have for him."
Ancelotti is set to have back surgery this summer to correct a long-standing problem and had indicated that he will take a break from football.
"I can assure you that I have not lacked opportunities, from Italy, England and Germany. And I will not lack [offers] between now and next year," he said last week.
"But I said it in the press conference and I repeat: I will stop for a year, also because I have a very serious reason for stopping.
"I have to have an operation because of my cervical stenosis. For some time, it has been affecting my hands and if I lose any more time, it could pass into legs, so I have an appointment for surgery.
"And, frankly, I do not know how long I have to be physically stopped, in terms of the post-operative phase and the subsequent rehabilitation."
