Magath becomes the first managerial casualty of the season with the club rooted to the foot of the Bundesliga.
Magath led Wolfsburg to the Bundesliga title in 2009, but according to a club statement, he volunteered to step aside "since the club has a predominant place in his heart" and he "did not want the club to suffer".
Magath was appointed to his second spell in charge of the Wolves just over 18 months ago and guided them to safety at the end of a difficult season.
Despite making wholesale changes to his playing staff in the summer of 2011, Wolfsburg nevertheless struggled last term and just missed out on a place in Europe, the aim they set themselves for the current season.
However, with only five points from the first eight games of this campaign, culminating in a run of four consecutive defeats with 10 goals conceded and none scored, that target has been placed in jeopardy resulting in Thursday's decision to go separate ways.
"Felix Magath took the first step in explaining to the board of directors that the club has a predominant place in his heart," read a statement from the Bundesliga club.
"He therefore offered to be relieved of his duties since he did not want the club to suffer.
"The board regrets that this situation has arisen, although both parties had tried everything in recent weeks to be successful.
"Since this did not succeed, this step has been agreed upon mutually. Lorenz-Gunther Kostner will take charge of the first team with immediate effect."
It is the second time Kostner, whose appointment was requested by the fans during Saturday's 2-0 defeat at home to Freiburg, has taken charge of the first team.
He replaced Armin Veh for the final four months of the 2009/10 season, but returned to his duties in charge of the reserves at the start of the 2010/11 campaign after Steve McClaren was appointed.
Once McClaren's reign came to an end, the club turned again to Magath, who had led them to a shock first Bundesliga title in 2009 and was having problems at Schalke, and he took over at the Wolves less than 24 hours after stepping down at the Royal Blues.
"We would like to express our gratitude to Felix Magath," said the club's chairman Francisco Garcia-Sanz.
"During his two terms at Wolfsburg, he has shown enormous engagement and achieved great things for our club, the city of Wolfsburg and sport in the whole region.
"The focus now lies on our coming games in which we need to get back in touch with midtable in the Bundesliga."
Wolfsburg travel to Fortuna Dusseldorf on Saturday.