The 84-year-old former Harrods owner has transformed the west Londoners from a third-tier outfit to an established Barclays Premier League side since taking over in 1997.
Sustained reports this week suggested Al Fayed would now sell the club and the Cottagers have tonight confirmed a deal has been struck with Khan, billionaire owner of the Jacksonville Jaguars.
"My time of serving as the custodian of Fulham Football Club would one day come to an end, and I feel that time has now arrived," Al Fayed said in a statement.
"The time is right because I have found a very good man in Shahid Khan to accept the responsibility and privilege that I have enjoyed at Fulham since 1997.
"Fulham will be in very good hands with Shahid, whose success in business and passion for sport is very evident.
"I ask everyone who loves Fulham and our Craven Cottage home to welcome Shahid as he begins his journey as the next guardian of Fulham Football Club."
Khan is worth £1.9billion, according to Forbes, making him the 490th richest man in the world.
Born in Pakistan, the 62-year-old moved to the United States aged 16 for college and secured an engineering degree from the University of Illinois.
Khan went onto create an auto parts empire and such riches allowed him to buy NFL franchise Jacksonville Jaguars, who will play one regular season game a season at Wembley for the next four years.
He said: "I was recently very fortunate to have been introduced to Mohamed Al Fayed, a man I respect and admire immensely for what he has accomplished in his life and - above all - what he has given others.
"Today, he is giving me the privilege and responsibility of serving as the next custodian of Fulham Football Club.
"I am extremely honoured to accept and want to thank him, on behalf of everyone who loves Fulham, for 16 years of exceptional service to the club.
"Mr Al Fayed rescued the club in its hour of need and has led it to a sustained place within the Premier League.
"Fulham is the perfect club at the perfect time for me.
"I want to be clear, I do not view myself so much as the owner of Fulham, but a custodian of the club on behalf of its fans.
"My priority is to ensure the club and Craven Cottage each have a viable and sustainable Premier League future that fans of present and future generations can be proud of.
"We will manage the club's financial and operational affairs with prudence and care, with youth development and community programmes as fundamentally important elements of Fulham's future."
Khan has big boots to fill, with Al Fayed leaving an extremely popular figure after transforming the club on and off the field.
Fulham reached the Europa League final three years ago and last season finished 12th in the league under the guidance of Martin Jol.
Off the field, the club is effectively debt-free after Al Fayed converted previous loans into equity earlier this year.
Training facilities have improved markedly and Craven Cottage has been revamped, with planning permission in place to redevelop the Riverside Stand and increase the stadium's capacity to 30,000.
Such is his popularity that more than 1,000 Fulham fans have already signed a petition to rename the Riverside Stand the Mohamed Al Fayed Stand.
Al Fayed: "Now is the right time for me to retire and spend time playing football with my grandchildren.
"I am sad but proud of our achievements. I am very grateful to Fulham's fans, the most incredible fans in the world.
"They have given me their support and affection whenever they have seen me at home games.
"I would never let them down. I have passed the club to a talented, honest and highly capable man who respects Fulham and its traditions. He is a great sportsman."