The 26-year-old Argentine, who shone after joining from arch rivals Olympiakos Piraeus in 2009, has not kicked a ball since January 2012 due to a knee problem.
"Panathinaikos announce the termination by mutual consent of their agreement with Sebastian Leto. We hope 'Seba' will return to action as quickly as possible and that he fully recovers from the serious injury problems which have affected him so much personally as well as the team," a club statement said on Tuesday.
"His talent, his contribution to the team, his passion and the bond he formed with the fans has earned him a special place in the history and the heart of the club."
Leto was in peak form when he broke down last season and his absence ultimately cost the Greens the title as they finished runners-up to Olympiakos having led the table for the first half of the season.
Leto, who had a stint with Liverpool from 2007-09 but barely played, was one of Panathinaikos' highest earners and the new ownership were keen to get the player off their limited wage bill.
The former Lanus forward scored 23 goals in 64 matches for the Greens.