Kolasinac joined the German club on loan in January after falling down the pecking order under Mikel Arteta.
The 27-year-old was expected to stay at Schalke beyond the end of his loan but that won’t happen after they were relegated from the Bundesliga.
Kolasinac will now return to Arsenal, with Schalke confirming that Klaas-Jan Huntelaar also won’t be staying with them.
“This decision hurts us both in sport and human terms,” said Peter Knäbel, director of sport and communication at Schalke.
“In view of the current budget and squad structure - all the known and publicly discussed challenges - there was no alternative.
“We have to be so honest. In view of the short preparation and the early start of the season, we cannot afford a week-long hang-up game either, but have to make decisions for Schalke 04 now.
“That’s why we decided on this clear cut.”