In a joint statement, the two companies said British Airways will have 55 percent of the new company, while Iberia will hold 45 percent.
Iberia's chairman Antonio Vazquez will be chairman of the new company, while BA's Chief Executive Willie Walsh will be CEO.
The deal is expected to be formalized in the first quarter of 2010 and closed by the end of that year, the two companies said.
Iberia said it reserves the right to back out of the deal if the final agreement between BA and the administrators of its pensin deficit is not reasonably satisfactory.
(Reporting by Tracy Rucinski and Andres Gonzalez; Editing by Jason Webb)