The forward, who helped the south coast side earn promotion to the Premier League following his move to St Mary's in January 2012, will be reunited with former boss Nigel Adkins
The former Sheffield United player joined the south coast club for a reported £1.8 million fee from Doncaster Rovers in January 2012, and immediately helped the club achieve promotion to the Premier League.
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He had been linked with a move to Sheffield Wednesday, Barnsley and former club Doncaster, but has decided on a reunion with Nigel Adkins, for whom he also played with at Scunthorpe United and Southampton.
"This is the third time I've worked with the gaffer now, and it is nice that he still believes in me and that helps a lot," Sharp told Reading's official website.
"As a footballer it's all about believing, it helps your confidence. Hopefully I can get my confidence high, hit the ground running and score some goals. I want to be a real asset for this club."
Sharp joins the likes of Wayne Bridge, Chris Baird and Royston Drenthe in making the switch to the Madejski Stadium, as the club look to make an immediate return to the Premier League.
The 27-year-old is in line to make his bow for the club against Birmingham City on Saturday.