United boss Jose Mourinho had been hoping to sign the Spain international this summer but Isco is happy to stay at the Santiago Bernabeu.
He played a crucial role under manager Zinedine Zidane last season as Madrid won the La Liga title and Champions League.
With just 12 months left on his contract, Isco had attracted interest from the Red Devils, Arsenal and Chelsea.
However, the 25-year-old was in top form on Tuesday night as he scored the winner to help Madrid beat United in the European Super Cup.
Speaking after the match, he told Marca that his new deal is now very close to being finalised.
He said: "It will be done soon, we're very close. Madrid is a very powerful team and we are happy.
"We played very well as a team and we winning is our obligation. The staff are doing a great job, we do not fail because of the relationship in the dressing room.
"We've built a winning group."