The Spaniard has fallen down the pecking order under Zinedine Zidane and was heavily linked with a move to Arsenal and Everton in recent weeks.
The report suggests that Milan could try to sign the 28-year-old midfielder to replace Turkish playmaker Hakan Calhanoglu, who has been linked with a move to Manchester United.
Isco joined Real Madrid from Malaga in the summer of 2013. He has won four Champions League crowns and two La Liga titles in his seven years at the club.
Isco has experienced many highs and lows at Real Madrid but has always remained a crucial member of the Los Blancos squad. However, his situation has changed in the last twelve months as he has finds himself becoming a bit-part player under Zinedine Zidane.
The Real Madrid midfielder is now keen to leave the Bernabeu in search of regular playing time as he looks to seal his place in Luis Enrique's Spain squad for next summer's European Championships.
AC Milan set to beat Arsenal in the race for Real Madrid midfielder Isco
Isco was largely tipped to join Premier giants Arsenal in January. The Gunners are desperate to sign a top-quality midfielder who will add creativity and goals to the squad.
Arsenal have frozen out Mesut Ozil from their squad and are looking for a permanent replacement for the German in January. It seems likely that they will be beaten in the race for Isco as the Spaniard reportedly prefers a move to AC Milan.
Milan's strong start to the Serie A season and their aspirations of mounting a serious challenge for the title are said to be the reason why Isco prefers a move to the San Siro over Arsenal.
Isco will reportedly cost AC Milan just €20 million, a figure that is definitely within reach of the Italian giants, who could close the deal without too many problems. The midfielder has given the green light to the move, and his friendship with Brahim Diaz means that this is an opportunity that the Rossoneri could seize.
Arsenal will now have to look at alternatives to Isco. The London giants are currently on a wretched run of form that sees them languishing in 15th place in the Premier League after losing six out of their opening eleven games this season.