The 42-year-old goalkeeper revealed he was set to sign a deal on Tuesday after leaving npower League One side Bournemouth by mutual consent last month.
James, who won the last of his 53 England caps in 2010, is set to take up a player-coach role alongside his former Portsmouth team-mate and IBV boss Hermann Hreidarsson.
"I am going to sign for #ibv in Iceland today. My role is as player/coach, alongside Herman. We are both very excited about the journey ahead," James wrote on Twitter.
One of James' first matches for IBV will be against Portsmouth in a charity match to help raise funds for the cash-strapped club at Fratton Park on April 16.
"I am also looking forward to playing for £ibv in the match at Fratton Park, 16th April. Lets hope the club is sorted, sharpish! £pup," he wrote.
IBV finished third in the Iceland domestic league last season and call the small Vestmannaeyjar islands - which have a population of just over 4,000 - off the south coast of the Nordic country home.