Ilan Grapel has been held in Egypt since June on suspicion of espionage and incitement to burn government buildings. He should be back in Israel by Thursday, Israeli government spokesman Mark Regev said.
The 25 Egyptian prisoners to be freed include three minors. They are not considered security prisoners, the prime minister's office said.
The exchange comes a week after an agreement between Israel and Hamas to ultimately free about 1,000 Palestinian prisoners resulted in the release of Israeli soldier held by Hamas for nearly five years.
Grapel, 28, is a former Israeli paratrooper. At the time of his arrest, he was studying law in the United States at Emory University in Atlanta, Georgia, a school official said.
Egyptian officials said Israel sent him to Egypt to recruit informants in the chaos that followed the January 25 revolution that led to the resignation of Hosni Mubarak as leader, but Israeli officials have denied that he was a spy.
His mother told CNN that Grapel had traveled to Cairo for volunteer work.
Last week, U.S. Secretary of State Hillary Clinton said the government saw "no basis for any legal action against him."
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