The 29-year-old was informed of the decision by Capello during a brief meeting at Wembley on Friday afternoon. The decision comes after allegations surrounding the Chelsea skipper's private life came to light.
"After much thought I have made the decision that it will be best for me to take the captaincy away from John Terry," said the Italian in a statement
Capello made it clear that while Terry's conduct on the field had been exactly what he wanted when he made his decision to appoint the central defender as skipper in August 2008, recent headlines about his personal life left him with little choice other than to remove the honour from the Barking-born player. It is alleged that Terry had an affair with Vanessa Perroncel, the ex-girlfriend of England team-mate Wayne Bridge, also a former club-mate of Terry's at Chelsea.
"As a captain with the team, John Terry has displayed extremely positive behaviour," added Capello.
"However, I have to take into account other considerations and what is best for all of the England squad.
"What is best for all of the England team has inspired my choice and John Terry was notified first."
Although Capello has not clarified whether he still intends to select Terry, Press Association Sport understands he has already confirmed Rio Ferdinand will replace the Chelsea man, with Steven Gerrard acting as his deputy.
"When I chose John Terry as captain, I also selected a vice-captain and also named a third choice," said Capello.
"There is no reason to change this decision.
"I would like to take this opportunity to thank the FA, particularly Lord David Triesman and Ian Watmore for allowing me to make this decision in my own time and in the best interest of the team."
Capello has only been in the job for just over two years but it is a measure of his standing within the English game that both FA chairman Lord Triesman and chief executive Watmore were happy to let him make the judgement.
Equally, team sponsors Nationwide have been quick to offer their support.
"The captaincy of the England football team is a matter for Fabio Capello and the Football Association. It is not a matter for the team sponsor," said Nationwide spokesman Chris Hull.
"These are private matters and not a matter for Nationwide. Nationwide is the England team sponsor and not the sponsor of any one individual."
Terry kept his own comments brief.
However, he had little option other than to accept Capello's decision and gave a broad hint that he would continue to be involved with the national team.
"I fully respect Fabio Capello's decision," Terry said in a statement released to Press Association Sport.
"I will continue to give everything for England."
The words disguise what is bound to be a bitter blow for Terry, and not a decision Capello would have taken lightly.
When most pundits expected the Italian to name Ferdinand as his skipper Capello felt the Chelsea star was better at galvanising the players around him.
Terry has done everything asked of him on the pitch as England have marched on towards this summer's World Cup in South Africa.
But there have been issues away from the pitch that have not sat easily with the suits at the FA.
Both Terry's parents have been in the headlines for the wrong reasons, while the defender himself was accused of using his role as England skipper for personal gain when an agency he was linked to included his status in an e-mail offering the player's services to enhance their business.
Terry emerged unscathed from all of this but last Friday, when a super-injunction, preventing details of an alleged affair with Vanessa Perroncel from being reported, was lifted by the High Court began the damage.
As the former girlfriend of Wayne Bridge and mother of the defender's son, Perroncel's name brought with it a whiff of scandal that only intensified with Terry's efforts to keep the affair out of the public domain.
At home in Switzerland, where he was recovering from major knee surgery, Capello could only look on aghast as the drip-feed of anti-Terry stories continued.
As trusted assistant Franco Baldini gauged reaction from various figures across the country, including Bridge's club boss at Manchester City, Roberto Mancini, Capello was told by senior FA figures he had full control over the decision.
Although Capello needed time, he was also aware the matter needed to be dealt with prior to his departure for Warsaw tomorrow ahead of Sunday's Euro 2012 draw.
He therefore called Terry to Wembley this afternoon for a meeting that consigned the Chelsea star to his new role as ex-England skipper.
There are still loose ends to be tied up before England's next engagement, against African Nations Cup winners Egypt at Wembley on March 3.
With Bridge due to make his comeback after a knee injury at Hull tomorrow, Capello must work out whether the former friends can be accommodated within the same squad.
There is also the not insignificant matter of Ferdinand's recent injury record.
The Manchester United defender did make a successful comeback after a long-standing back complaint a fortnight ago but has featured in only four of England's last 12 internationals.
It is hardly an ideal record heading into such a big tournament, although Ferdinand's quality when fully fit is not in question.
The move caught bookmakers by surprise as they had only just installed Gerrard - vice-captain under Terry when Steve McClaren was in charge - as favourite to take over.
Ferdinand's Manchester United team-mate Wayne Rooney was second favourite, having done the job for the first time in Qatar in November when England lost to World Cup favourites Brazil.
Rooney has never made any secret of his desire to do the job on a permanent basis but as England's best player, Capello might have deduced that asking the striker to take on the captaincy as well, at just 24, might have been too much responsibility.