Essex skipper Irani, 35, who began his career with Lancashire, said Wednesday he didn't see himself playing beyond the end of the current campaign.
In a statement, Irani said: "Essex have recently offered me a new two-year contract that would take me through to the end of the 2009 season.
"However, due to my injury situation and based on the advice of those close to me, I have had to inform the committee that I am unable to accept it.
"The offer was wonderful but my right knee condition is so acute that I would be kidding everyone if I accepted it.
"Since I gave up bowling in 2003 my batting has really come on but my deteriorating health means that there is no realistic chance of me playing a meaningful role in the 2008 or 2009 seasons."
Irani, a medium-pace all-rounder, played three Tests for England between 1996 to 1999 and appeared in 31 one-day internationals, the last at the 2003 World Cup in South Africa.
He enjoyed one-day succes at county level, helping Essex win the Benson and Hedges Cup in 1998 and steering them to back-to-back successes in the domestic 40-overs league in 2005 and 2006.
"I've had a great time with Essex and loved every minute. While I'm immensely disappointed, I want to make sure that every one of the club's supporters will say that Ronnie Irani gave everything and that he never took a penny without performing.
"By the end of 2007 I'll have given it my all and I hope people will realise that I couldn't give any more.
"I'd like to thank all the Essex members, supporters and the committee who have been wholly behind me and given me everything I've ever dreamed of.
"As a young man you want to make your way in the game as a professional cricketer and although I was fortunate enough to play for England my heart and soul lies with Essex County Cricket Club for what they have done for me.
"I'd like to finish this season as captain in the games that I can. Although I'm not going to be able to fulfil all the matches because of my knee condition I want to be able to play as many one-day games and maybe a few Championship matches too."