The 31-year-old began his career at Fir Park before moving to England to play for Everton, Birmingham and Sunderland.
McFadden returned to the Steelmen in February 2013 and signed on again last summer, starting 23 times during the latest campaign and scoring five times as Stuart McCall's side finished runners-up in the Scottish Premiership.
McCall told the club's website: "I had James in last Friday and we had a discussion about the future and everything was very amicable.
"I cannot speak highly enough of his attitude, desire and professionalism whilst he was here, particularly when going through a difficult patch or when he was injured.
"In the past, we could possibly have used James in a number of positions, but I think he is at his best when played through the middle as a striker.
"We have five different options in that position and need to utilise the budget in other areas of the squad."