General manager Buddy Nix says he informed Nelson's agent of the decision Sunday.
Nelson is coming off a torn ACL, which he hurt Sept. 9 against the Jets. He had surgery shortly after being hurt and anticipates he'll be ready for the start of training camp this year.
It's the latest move by the Bills to cut ties with their immediate past since Doug Marrone took over as coach last month. The Bills decided not to extend third-year receiver Donald Jones a contract offer earlier this month. They have also released two veterans, linebacker Nick Barnett and safety George Wilson.
Nelson will now prepare to become an unrestricted free agent. The move wasn't entirely a surprise for Nelson after the team fired coach Chan Gailey following a 6-10 finish last year.
In confirming the Bills' decision on his Twitter account, Nelson wrote he's "excited for the next opportunity."
Nelson made the Bills in 2010 as an undrafted rookie free agent out of Florida, after enjoying a successful senior season as one of Tim Tebow's top targets in helping the Gators win the national championship.
At 6-foot-5 and 204 pounds, Nelson became a dependable contributor during his first two seasons with a combined 92 catches for 1,011 yards and eight touchdowns.
The Bills have added receiver to their list of offseason needs. The team now returns only two regular receivers, starter Steve Johnson and undersized speedster T.J. Graham, who made a limited impact as a rookie last year. Brad Smith, who doubles as a wildcat quarterback specialist, also saw limited time at receiver last season.
Information from The Associated Press was used in this report.