The former St Patrick's Athletic midfielder will not have his contract renewed with the Blues and will become a free agent from June 1 2013
The 30-year-old Republic of Ireland international is one of a number of players to depart the Blues and will become a free agent from June 1, 2013.
Fahey joined Birmingham from St Patrick's Athletic in 2009 for a fee believed to be in the region of £300,000 (€360,000), making over 140 appearances during his spell at the club.
The midfielder announced via Twitter that he was "very sad" to be leaving the Championship club and thanked the fans for their support.
Fahey had recently returned to the club after a period away from football on compassionate leave. He made just nine appearances this season.
Meanwhile, Birmingham City striker Adam Rooney is set to join Swindon Town on a permanent basis, it has been confirmed.
The former Republic of Ireland under-21 international, who joined Birmingham in 2011 from Inverness Caledonian Thistle, had spent the majority of the 2012-13 season on loan with the Robins, scoring 10 goals in 31 appearances.