The 28-year-old, who came through the youth ranks at Middlesbrough where he played Barclays Premier League football, will remain at Bloomfield Road for one more year, with the option of a further 12 months.
McMahon originally joined the Seasiders on loan from Sheffield United in January before making the move permanent shortly afterwards. It was the right-back's second stint at the club following a brief spell in 2007.
He made 18 appearances last season and helped Blackpool preserve their Sky Bet Championship status.
Meanwhile, experienced midfielder Keith Southern is set to leave the club having agreed to join north-west neighbours Fleetwood.