The Italian Olympic Committee, also known as CONI, said Monday that Schwazer tested positive for doping and has been removed from the team.
CONI President Gianni Petrucci said Schwazer had admitted to doping on what was a "bitter day" for Italian sports.
Earlier Monday, the team said an unidentified athlete had failed a doping test conducted for the World Anti-Doping Agency before arriving in London. Details of the offence were not given.
The 27-year-old Schwazer had been due to defend his 2008 Olympic title in the 50-kilometre walk on Saturday. Schwazer won gold at the Beijing Games in an Olympic record time of 3 hours, 37 minutes, 9 seconds.
His doping confession Monday meant "one less medal but more cleaning" house, Petrucci told Italian state television.
Schwazer's agent, Gloria Mancini, told The Associated Press that his entourage had no idea he was doping.
"We are bitterly surprised," Mancini said in a telephone interview. "Especially since this is an athlete who has always condemned doping in the strongest terms."
The Italian athletics federation said it was notified of Schwazer's doping test results on Monday afternoon.
"While fully agreeing with CONI's choice, (the federation) expresses deep disappointment for what happened, underlining its strong stance of condemnation against every form of doping," it said in a statement.
Schwazer also had entered last Saturday's 20K walk, but withdrew citing a cold, the official London Olympics website said.
The two-time world championships bronze medallist works as a police officer, according to his biography on the site. He is one of the best known athletes in the 286-member Italian team at the London Games.
Schwazer's profile has been raised at home because his girlfriend, Carolina Kostner, is the reigning women's figure skating world champion.
Associated Press writer Maria Sanminiatelli contributed to this report.