The 44-year-old will leave the club after rejected a contract having just won the Scottish Cup in his first season at Tynecastle
The Portuguese, who led the club to Scottish Club glory, could not agree a deal to extend his stay in Scotland.
First-team coach Gary Locke will remain at the club as the club stressed that Sergio’s exit would not trigger a mass departure of players.
A statement on the official club website said: "The club had been hopeful recent negotiations with Sergio would have a successful conclusion but he has opted not to extend his stay at Tynecastle."
"Paulo Sergio declined the offer of a new contract. We wanted to keep Paulo Sergio at Hearts and made what we believed was our best offer in the circumstances.
"We would like to put on record our appreciation of all his efforts, and those of Alberto Cabral and Sergio Cruz, in bringing the Scottish Cup back to Tynecastle.
"The same terms will be available to other candidates willing to lead Hearts to new victories. The search is already underway to find a new manager and we hope to make an announcement as soon as possible."
With money tight at the Scottish club, Sergio admits he couldn’t agree to the deal Hearts had offered him.
Sergio spent eight years managing in Portugal which included a stint at Sporting Lisbon before joining the club last August and the former forward admits his future is unclear.
He said: "I appreciate the road the club is now going down and respect what our board is doing. But I cannot accept the offer the club has made me.
"I want to say many thanks to everybody who worked with us, including our board, and special thanks to our supporters.
"I wish the very best to this great football club and I am now just one more Hearts supporter. I would also like to say thank you to all the players, who will be friends for life.
"And as for my future? Only God knows."
The Edinburgh club are now looking for their 12th manager since 2005