The 45-year-old replaced Portuguese Andre Villas-Boas in December after a spending spree fuelled by the world-record sale of Gareth Bale to Real Madrid failed to propel them to new heights and they were seventh in the table after thrashings by Liverpool and Manchester City.
"It is obviously a massive wrench to leave a club of the stature of Tottenham Hotspur, a club very close to my heart," he told Sky Sports News.
Sherwood signed an 18-month contract when he took over as manager but was widely expected to leave at the end of the season, despite leading them to sixth place and another season in the second-tier Europa League.
"We appointed Tim mid-season as someone who knew both the players and the club," chairman Daniel Levy said in a statement.
"We agreed an 18-month contract with a break clause at the end of the season and we have now exercised that option."
Sherwood, who played nearly 100 league matches in midfield for Spurs after winning the Premier League with Blackburn Rovers, rejoined the club as assistant first-team coach in 2008 and progressed through the ranks until he was handed his first senior management role.
Speculation had mounted in recent months that Sherwood would not last beyond this season, despite having the highest winning percentage of any Spurs manager in the Premier League era.
He never appeared to have the full backing of the notoriously ruthless Levy, who has now used eight managers and two caretaker bosses in his 13 years at the club and failed to acknowledge Sherwood in his end-of-season message to supporters.
SUPPLY TEACHER
Frank de Boer of Ajax Amsterdam and Southampton's Mauricio Pochettino have been linked with the job, with Sherwood saying last week he felt like a "supply teacher".
"On behalf of the club, I should like to state our thanks for all his efforts during his years with us," Levy said.
"We wish him great success in his managerial career.
"Moving forward, now the season is over, we shall embark on the process of finding a new head coach. We have a talented squad and exciting young players coming through. We need to build on this season, develop our potential and inspire the kind of performances that we associate with our great club."
Spurs are desperate for regular Champions League appearances and following the sale of Bale they signed seven players, many with big reputations but none with English experience.
The likes of Erik Lamela and Roberto Soldado failed to fire, although Danish midfielder Christian Eriksen and Romanian centre back Vlad Chiriches showed towards the end of the season that they were getting to grips with the Premier League.
Helping the new arrivals settle appeared beyond Villas-Boas, and arguably Sherwood's biggest triumph, alongside bringing youngsters like forward Harry Kane and Algerian midfielder Nabil Bentaleb into the first team, was getting the best out of enigmatic striker Emmanuel Adebayor, who had been frozen out under the previous regime.
Having had no senior management experience, Sherwood wore his heart on his sleeve, accusing some of his players of "lacking guts" after a 4-0 defeat at Chelsea in March.
He was often pictured hurling clothes or kicking water bottles on the sideline.
During Sunday's 3-0 win over Aston Villa he invited a fan to briefly sit in the dug-out, indicative of his approach to the game that found favour with some but failed to convince many he had the skills to take Spurs to the next level.
(Editing by Ed Osmond and Julien Pretot)
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