The two groups have long disputed whether the so-called ‘put option’ was valid, with Fiat saying that it has been held back by other partnerships that would help cut costs and return to profit.
"We now have absolute freedom to design our own future," Fiat CEO Sergio Marchionne told a news conference on Sunday, saying he wanted focused partnerships in specific business areas - but not another GM-style equity-and-industrial alliance.
Under the new deal, GM and Fiat said they will dissolve their two joint ventures in powertrains and purchasing, although Fiat will continue to provide GM with diesel engines and will have access to GM's global purchasing team and its economies of scale.
GM will pay Fiat €1bn (£689m) on Monday and another €550m (£378m) when the joint ventures are dissolved, within 90 days, Marchionne said.
Corrado Passera, CEO of Fiat creditor Banca Intesa, said the deal was "in line with our highest hopes”.
GM bought 20% of Fiat Auto in 2000 for $2.4bn (£1.27bn), but its stake was halved under a recapitalization which GM argued had invalidated the put option.
Despite the latest drain on its financial resources, GM CEO Rick Wagoner said the deal was worth it.
"We needed scale in Europe to get costs down and we were able to do that working with Fiat," Wagoner said. "Frankly, it's a fairly high return initiative for GM, admittedly not exactly the way we had foreseen it to play out."
The Fiat deal gave GM access to its diesel engines in Europe, where diesel accounts for 40% of car sales.
"Not only did we not have the facilities or the product development, we didn't even have diesel engineering capability," Wagoner said.
Under Sunday's deal, GM and Fiat will continue to co-own a factory in Poland which makes the 1.3 liter Multijet engine. The plant was owned by Fiat before the GM venture was set up.
Fiat Chairman Luca di Montezemolo said if the groups had not reached a deal by the coming week, Fiat had planned to start exercising the put option on Fiat Auto.