The 19-year-old will spend the 2021-22 season at the League One side after Nuno Espirito Santo gave the green light for him to leave on loan.
Parrott had hoped to make a case to be included in the Spurs squad this season after being overlooked by Jose Mourinho last season.
The Republic of Ireland international spent the first half of last term on loan at Millwall in the Championship but made just 14 appearances during an injury-hit start to the season.
Parrott then joined Ipswich Town on loan in League One during the second part of the season, scoring twice in 18 appearances.
The golden boy of Tottenham's academy, at MK Dons he will be aiming to showcase the talent that attracted interest from Bayern Munich and Borussia Dortmund before he signed a new contract with Spurs last year.
“I’m really happy to be here,” said Parrott after joining MK Dons. “The way that the team plays suits me and the way that I want to play – I’m looking forward to being a part of it.
“I hope to bring goals to the team, of course, but I also want to contribute by linking play and getting on the ball as much as possible. I’m just happy to be here now and I can’t wait to get going.”
MK Dons manager Russell Martin said: “Troy is somebody we have had our eyes on for a while so we are delighted to be able to work with him.
“There was a lot of interest in him so we are thankful to Spurs for trusting us with his development, but also to Troy for his commitment and desire to be here. We are excited to see what he can do for us this season.”