Larsson has been involved in negotiations which first opened two years ago following their relegation from the Premier League.
The Sweden international could not make his mind up on his future even after City returned to the top flight.
As a result Blues took up a 12-month option on his current contract which will run out next summer.
If the two sides cannot reach an agreement, then Larsson will be free to talk to interested parties in January and possibly sign a pre-contract agreement.
The 25-year-old's representatives met with Birmingham's acting chairman Peter Pannu on Thursday.
The former Arsenal player has said on several occasions in the past that he would prefer to remain at St Andrew's.
Meanwhile, City remain confident manager Alex McLeish will finally put pen paper on a new deal sooner rather than later.
Pannu was at pains to point out yesterday that his remark in an interview that McLeish was "no Mourinho" had not caused a rift between the pair.