The textile dates to 1855 and belonged to the Jewish community in the town of Mlada Vozice, 50 kilometers (30 miles) south of Prague. It is believed to have been used in the local synagogue, which no longer exists.
It was confiscated by the Nazis in 1943 during Czechoslovakia's occupation by Hitler's troops. The Nazis gathered items from Jewish communities at a depository in Prague before killing Jewish residents in death camps.
None of the 68 Jews who lived in Mlada Vozice survived the Holocaust. Most died in the Nazis' Auschwitz and Maly Trostinec camps.
The piece's whereabouts have been unknown for almost 60 years. It was discovered by curators of Prague's Jewish Museum in 2013 in the U.S. shortly before Sotheby's was to put it up for auction in New York among more than 400 other Jewish treasures in April.
Officials at the Jewish Museum, where the textile was kept after the war, said it disappeared under unclear but likely illegal circumstances in 1956 along with other pieces from the museum's collection.
Jana Havlikova of the museum said the agreement to return the piece to the country included no financial compensation.
"It is an example to follow," said Petr Papousek, head of the Federation of Jewish Communities in the Czech Republic.
Papousek said the textile is priceless for Czech Jews because "we can identify it with the people who were murdered in the death camps."
According to the museum and Jewish federation officials, it is the first time a ceremonial Jewish piece that was stolen during the Holocaust has been traced abroad and returned to the country.
It will go on display at the Prague museum starting April 24.