The state court in Ellwangen, in southwestern Germany, said in a statement it had concluded that Hans Lipschis was suffering from the onset of dementia, based on two meetings with the suspect and a psychiatric assessment, and that he was easily disoriented.
"It is very likely that the accused can no longer follow a criminal trial of this magnitude, complexity and length sufficiently and could therefore no longer adequately defend himself against the serious charges," the court said.
It was not clear where Lipschis would go, and his attorney was not immediately available for comment. Lipschis has been held in a prison hospital.
Though the court still has to formally decide whether to open the trial against him, it said that it was ordering his release from custody because there was "considerable doubt that the accused is fit to stand trial" and thus it isn't very likely he would be convicted.
Lipschis has acknowledged being assigned to an SS guard unit at Auschwitz but maintains he only served as a cook and was not involved in any war crimes.
Lipschis is one of some 30 suspected former Auschwitz guards against whom the special German prosecutors' office that investigates Nazi war crimes said in September it had found enough evidence to warrant accessory to murder charges.
The Lipschis case was the one that had progressed furthest, and the fact that it now looks unlikely to go to trial illustrates the challenges ahead for state prosecutors who are now investigating whether to bring charges against the others.
Lipschis was deported from the U.S. in the early 1980s for lying about his Nazi past when he immigrated to Chicago in 1956, and he has lived in Germany since.
He went uncharged, however, until after the 2011 conviction of Ohio autoworker John Demjanjuk in Munich, whose case established a new precedent after he was found guilty of accessory to murder as a Sobibor camp guard even though there was no evidence he committed a specific crime.
The court agreed with the prosecution's argument that anyone who was a guard at a camp whose sole purpose was murder could be charged as an accessory to that act.
The Auschwitz cases, including Lipschsis', are being pursued under that same theory even though Demjanjuk—who denied ever being a guard anywhere—died while his case was still being appealed.
Lipschis was taken into custody in May after authorities concluded there was "compelling evidence" he was involved in crimes at Auschwitz while he was a guard there.
Stuttgart prosecutors in late September charged him with 10,500 counts of accessory to murder in connection with the deaths of people slain in Auschwitz while he was alleged to have been there.
Stuttgart prosecutors were not available for comment on whether they would try to appeal the court's decision to release Lipschis.
About 1.5 million people, primarily Jews, were killed at the Auschwitz camp complex between 1940 and 1945.