The new deal will keep Ancelotti at AC Milan until 2010. The 47-year-old’s contract was set to expire at the end of next season.
Ancelotti won the club’s seventh European Cup with a 2-1 win over Liverpool last week in Athens.
He told the club’s official website: “I am very pleased to have reached this agreement and I feel happy to continue here.
“We have won the Champions League because in November the board have given me their confidence, while others talked about other coaches. Adriano Galliani is a great director.”