McDermott, who took over as manager in 2009, has turned the club from relegation battlers to Championship play-off contenders during his short reign and his side are currently just three points behind sixth-placed Nottingham Forest with a game in hand.
He told the club's official website: "I am absolutely delighted, this is the place I want to be and the club I want to work at.
"I've been here close to 11 years and I feel very much part of things. I'd like to thank the chairman, the board and Nick Hammond, and I'm also fortunate to have fantastic staff and players.
"As a club we have continuity, it's a great place to work and a great place to be. Now we look to the rest of the season, we've got nine games left and so much to play for."
Chairman Sir John Madejski added: "Brian has done a magnificent job for Reading football club, and I am absolutely delighted with this agreement."