It will sell 150 stores and Fresh & Easy's distribution and production facilities to American investment firm Yucaipa Companies.
But Tesco admitted 50 stores were not part of the deal and will close over the coming weeks, affecting around 1,000 US jobs.
The decision comes as Tesco confirmed it was in talks with China's largest retailer to merge their operations in the country. The move marks a shift in strategy over one of its key growth markets.
Tesco said the merger with CR Vanguard - owned by state-run China Resources Enterprise (CRE) - would create a business with more than 3000 stores and combined sales of around £10 billion.
But the deal leaves a question mark over the future of the Tesco brand in China and would bring an end to the group's independent business in the fast-growing retail market.
Tesco would own a stake of 20% in the joint venture after bringing its 131 stores in the country together with Vanguard's 2986 shops in China and Hong Kong.
Tesco, which has agreed a memorandum of understanding with CRE, said the proposed tie-up is consistent with its "strategy of focusing on profitable routes to growth in fast-growing but less mature markets, with a disciplined approach to the allocation of capital".
It added that the merger talks follow a series of joint ventures struck between CRE and other multi-national companies.
Tesco's recent first quarter trading update revealed tougher trading in China as like-for-like sales dropped 4.9% in the country, following a 2% decline the previous three months.
Tesco is focusing its efforts on turning around its domestic operations after falling market share and intense competition prompted the chain's first profits warning in 20 years in January 2012.
Chief executive Philip Clarke unveiled a £1bn overhaul in April last year and recently revealed a shift in strategy away from increasing store space to modernising its existing shops, while also focusing more on convenience outlets and online sales. The group's Chinese operation has grown from 56 stores to more than 130 in five years.
Tesco China also includes the six-strong Lifespace shopping mall business.
Vanguard was set up in 1999 and is owned by CRE, a Hong Kong-listed company