The announcement comes the day after a 3-2 El Clásico defeat to Barcelona in the Spanish Super Cup final, and with the club second in La Liga, four points off the top spot.
"Real Madrid announces that, by mutual agreement between the club and Xabi Alonso, it has been decided to bring his tenure as first team coach to an end," said the Spanish giants in a statement.
A separate announcement then confirmed the appointment of former Madrid and Liverpool defender Alvaro Arbeloa as his replacement.
"Real Madrid communicates that Alvaro Arbeloa is the new coach of the first team.
"Arbeloa has been the coach of Castilla since June 2025 and has developed his entire coaching career in Real Madrid's academy since 2020."
Alonso arrived at Madrid following a successful stint as Bayer Leverkusen manager, where he won the club's first-ever Bundesliga title after an unbeaten league campaign.
His time in the Spanish capital saw some success, including a 2-1 win over Barcelona in La Liga and a victory by the same scoreline against Atletico in the semi-finals of the Super Cup.
He departs the club with a record of 22 wins, four draws and just five defeats.