The decision was announced at a press conference after a bitter dispute between Lieberman and Netanyahu over a range of issues.
Lieberman, who heads the right-wing nationalist Yisrael Beiteinu, had formed an electoral alliance with Netanyahu 20 months ago.
On Monday, Lieberman acknowledged that disagreements with Netanyahu are the reason for ending ties with Likud, adding that the partnership did not work as the two parties are divided on technical issues.
“It’s no secret that there are fundamental disagreements which no longer allow us to work together, so we have advised the Knesset committee that we are separating and setting up a separate faction,” Lieberman said.
The Israeli foreign minister has, however, noted that the end of the partnership will not affect the coalition and that his party will continue to hold key portfolios.
On Sunday, Lieberman and Netanyahu traded verbal blows at a cabinet meeting.
Lieberman is critical of Netanyahu’s plans to deal with the Palestinians. He is also calling for a large-scale military operation in the besieged Gaza Strip.
The developments come as the Palestinian resistance movement, Hamas, says seven members of the movement have been killed in Israeli airstrikes on the besieged enclave, saying Tel Aviv will “pay the price.”
The movement said seven members of the Ezzedine al-Qassam Brigades were killed in the attacks early on Monday and four others were injured.
Israeli military officials said they targeted nine sites and that the attacks made “direct hits.”