The deal will keep the Ivory Coast international at the Etihad Stadium until 2017.
"This is where I want to be," the 29-year-old told the club website.
"I will never forget how I have been treated here by the fans, the club and the owners and nothing would give me greater pleasure than to finish my career as a Manchester City player."
Toure joined City from Barcelona for a reported £24m in 2010, having helped the Spanish giants win the Champions League title a year earlier.
The box-to-box midfielder has since been an integral member of Roberto Mancini's side, scoring the winning goal in the 2011 FA Cup final and a crucial double against Newcastle United last May to keep the eventual Premier League champions in the title hunt.
We must try to finish on a high note and then start preparing to win more next season
Toure has scored eight goals this season as City have progressed to a Wembley FA Cup semi-final against Chelsea on Sunday 14 April, but his side made an early Champions League exit and are 15 points behind Manchester United in the league with only seven games remaining.
"Of course now it looks likely that we will not successfully defend the Premier League title and that is sad for all of us," Toure added. "But we can still finish second and win the FA Cup for a second time in three years and that is still an achievement for a club that won nothing for a long time.
"We must try to finish on a high note and then start preparing to win more next season. Football is always a challenge and always a puzzle to solve and that is why we all love the game.
"You have to use your skill, intelligence and strength to constantly improve and that is what we at City intend to do."

The party, which was the third biggest group after the last local election, took four seats from Labour, one from the Tories and one from an independent.
The final result at the Little Thurrock Blackshots ward was won by the Conservatives by one vote over the UKIP candidate after three recounts.
UKIP and the Conservatives have 17 seats each, and Labour 14.
There is one independent. The parties are now in discussion about whether a coalition can run the authority. Thurrock Tory group leader Rob Gledhill and UKIP leader Graham Snell said they believed they could work together.
Basildon - where UKIP took two seats, one from Labour and one from the Lib Dems - and Southend-on-Sea councils remained with no one party in overall control.
Harlow Council was held by Labour, and Castle Point and Brentwood councils were held by the Conservatives.
Colchester City Council remains with no party in overall control. The counts for Rochford Council and Epping Forest are taking place on Friday.
The tensions at the Backstage Centre in Purfleet were palpable. Just when the final declaration seemed imminent it went to a third recount and became even more nail-biting.
Thurrock was a top target for UKIP on a national basis, and in the end they fell agonisingly short in coming out level with the Conservatives. Nonetheless, they're jubilant at having picked up six seats, which the leader Graham Snell puts down to his colleagues' hard work on local issues such as housing, jobs and the environment.
Thurrock is now in an unprecedented situation with joint council leaders. Graham Snell and Robert Gledhill agree that there is common ground on about 70% of issues. In particular, they're united in their opposition to any new Thames river crossing coming through Thurrock.
Manchester City midfielder Yaya Toure has signed a new four-year contract with the Premier League club.
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UKIP have won six seats on Thurrock Council, missing out on being the largest party by a single vote.