It is not the first time he has parted company with Ian Paisley
He said he was leaving the party with immense sadness but that he felt Sinn Fein was "not fit for government".
It comes after a ground-breaking meeting between Ian Paisley and Gerry Adams at Stormont when they agreed to share power on 8 May.
Mr Allister said he would not be giving up his seat as an MEP.
He said the DUP had not delivered on its election manifesto and accused Sinn Fein of "weasel words".
Mr Allister, who previously left the party after a disagreement in the 1980s, was opposed to the DUP executive resolution committing to power-sharing.
He announced his decision at a news conference in east Belfast.
It seems to me that, sadly, the lure of office has clouded the party's judgment
Jim Allister
He said: "To continue as the DUP's MEP, it would be my obligation to accept the party executive policy decision to usher Sinn Fein into government in a few short weeks.
"This, in conscience, I cannot do. Thus, I must resign from the DUP.
"Sinn Fein, in my view, is not fit for government. Nor can it be in a few weeks."
He added: "I have fought a protracted battle within the party over recent months against a premature DUP/Sinn Fein government.
"I now have to accept that this battle is lost."
The MEP said if Sinn Fein believed the IRA was truly and irreversibly committed to exclusively peaceful means, there was no need for an IRA army council.
"I just cannot comprehend how the DUP can contemplate government, particularly where it will be joined at the hip in the Office of First Minister and Deputy First Minister, with an organisation which clings to an illegal army council of an illegal army," he said.
"It seems to me that, sadly, the lure of office has clouded the party's judgment."
Ulster Unionist MEP Jim Nicholson said Mr Allister's resignation was "not a huge surprise".
"I would like to assure him that regardless of his political affiliation, I have every intention of maintaining the good working relationship we have had since he was elected to the European Parliament," he said.
'Unrepentant terrorists'
Meanwhile, Ballymena DUP councillor Sam Gaston has stepped down from the party as a result of Monday's developments.
Mr Gaston said six weeks was not enough for republicans to prove themselves.
"I think they have gone into government too quickly," Mr Gaston said.
"I think those people who have suffered deserve that we don't have unrepentant terrorists in government."
Mr Allister was elected to the European Parliament in 2004, ending a 17-year absence from frontline politics.
BBC Northern Ireland political editor Mark Devenport said: "On Saturday, he was one of the members of the 120-strong DUP executive who voted against the resolution committing the party to sharing power in May.
"He drove away from Castlereagh council before Ian Paisley emerged, flanked by the majority of his colleagues."
The MEP was known to oppose power-sharing
It is not be the first time he has parted company with Ian Paisley.
In the 1980s, he left active politics after disagreeing with his leader's tactics after the Anglo-Irish Agreement.
His return to the DUP fold to stand as an MEP surprised those who believed he had already given up politics to concentrate on his legal career.
Last October, Mr Allister said the St Andrews Agreement had definite gains but also fundamental negatives.
He said disadvantages included the length of the testing period for Sinn Fein and enforced mandatory coalition.
He also said there was no mechanism to exclude Sinn Fein if it "defaulted", other than to punish all parties.
Mr Allister said it would be "intolerable for any unionist" if the IRA army council was still in existence when the parties are due to share power. He said this would be a deal-breaker for him.
, the  (DUP)  (MEP) for Northern Ireland, resigned because of his party's decision to enter into a power-sharing Government with . Mr Allister said that party colleagues had been "lured by office" and that he had not returned to politics in 2004 to "help ease Sinn Féin into Government". He acknowledged that although he had fought within the DUP against Sinn Féin being permitted to be members of the , he had failed to persuade the vast majority of the party's ruling executive on the issue. Yesterday, Ian Paisley, DUP leader, and Gerry Adams, Sinn Féin President, agreed to enter into a power sharing executive in May. This is the second time that Jim Allister has resigned from the DUP over disagreements with Ian Paisley entering pacts with other political parties.