Microglia play a pivotal role in the 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 the brains of people with AD. The APOE pathway mediated a switch from a homeostatic to a neurodegenerative microglia phenotype after phagocytosis of apoptotic neurons. TREM2 (triggering receptor expressed on myeloid cells 2) 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 had lost their tolerogenic function. Our work identifies the TREM2-APOE pathway as a major regulator of microglial functional phenotype in neurodegenerative diseases and serves as a novel target that could aid in the restoration of homeostatic microglia.