The 21-year-old has signed a five-year contract with the Spanish giants.
Real Madrid wrote on their Twitter: “Real Madrid C.F. & Málaga C. F. have reached an agreement for the transfer of Isco who will play for the Whites for the next 5 seasons.”
New Manchester City boss Manuel Pellegrini was keen to bring the youngster to Eastlands.
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Liverpool have unveiled their new home kit for next season, sticking with the hugely popular retro styling of the current shirt.
The reputation of the Premier League means it is the most popular and one of the most watched leagues in the world.