The Bulgarian striker was due to be a free agent at the end of June after signing a short-term deal with the Principality club in January following his release from Premier League side Fulham.
But the 33-year-old has impressed during his time at the Stade Louis II, scoring nine goals in 14 appearances in all competitions for Claudio Ranieri's side and helping them secure a place in next season's UEFA Champions League.
And the former Manchester United man has been rewarded for his fine form since making the move to the Cote d'Azur.
"I feel at home here. It's going to be an interesting season," Berbatov told Monaco's official website.
Club vice-president Vadim Vasilyev added: "With AS Monaco, Dimitar showed all of his talent. He is a great player and we are very proud to have him for the next season."
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