The Turkish midfielder, who has been at the club since joining the academy in 2003, has put pen to paper on a deal that will run until the end of the 2014-15 campaign
The former Turkey Under-21 international joined the Royals academy as a 14-year-old in 2003 and made 37 appearances last season as they secured the Championship title.
Karacan finished second in the club's player of the season voting for the 2011-12 campaign and has now extended his stay at the Madejski Stadium until 2015.
"I'm delighted to finally get it done, we've been in negotiations for a little while so it's nice to put pen to paper," the 23-year-old told the club's official website.
"Ever since I arrived, I've always wanted to become a first-team regular and in the last couple of years I've managed to do that - to come through the ranks has been brilliant."
Reading manager Brian McDermott, meanwhile, was pleased to secure the future of one of the club's homegrown players.
"We are delighted that Jem has committed to us, he's been an integral part of what we've been trying to do," he enthused.
"He's a great lad who is very much one of our own and we're really pleased that he has signed a new deal."