Microglia play a pivotal role in maintenance of brain homeostasis, but lose homeostatic function during neurodegenerative disorders. We identified a specific apolipoprotein E (APOE)-dependent molecular signature in microglia from models of amyotrophic lateral sclerosis (ALS), multiple sclerosis (MS) and Alzheimer’s disease (AD) and in microglia surrounding neuritic β-amyloid (Aβ) -plaques in human AD brains. The APOE pathway mediated a switch from a homeostatic to neurodegenerative microglia phenotype following phagocytosis of apoptotic neurons. Triggering receptor expressed on myeloid cells 2 (TREM2) induced APOE signaling, and targeting the TREM2-APOE pathway restored the homeostatic signature of microglia in ALS and AD mouse models and prevented neuronal loss in an acute model of neurodegeneration. APOE-mediated neurodegenerative microglia led to a loss in their tolerogenic function. Taken together, our work identifies the TREM2-APOE pathway as a major regulator of microglial functional phenotype in neurodegenerative diseases and serves as a novel target to restore homeostatic microglia. Microglia change their phenotype and function during aging and neurodegeneration, but the underlying molecular mechanisms for this change remain unknown. Krasemann, Madore, et al. identify the TREM2-APOE pathway as a major regulator of microglia phenotypic change in neurodegenerative diseases, which may serve as a target to restore homeostatic microglia.