The Spanish Paralympic Committee (CPE) said it had ordered the medals to be handed back after an inquiry found ten of the 12 members of the basketball team suffered no mental handicap.
The investigation also uncovered isolated irregularities in other sports.
The CPE said it was continuing investigations to determine the eligibility of three other athletes, two of whom were medallists.
The scandal has already prompted the resignation of Fernando Martin Vicente as vice-president of the CPE and president of the Spanish Federation for Mentally Handicapped Sports (FEDDI), despite his denial of any wrongdoing.
Officials said Vicente would be expelled from the CPE.
"We have decided to expel Fernando Martin Vicente from the CPE for actions that were clearly contrary to the interests of the Spanish and international Paralympic movement," the committee said in a statement
It said it would implement immediate procedures to ensure that all Spanish Paralympic competitors met the criteria for participation in Paralympic sports and were legally registered as handicapped.
The CPE said the investigation would be expanded to cover alleged irregularities in the funding and sponsorship of Spanish Paralympic sports.
"The CPE deeply regrets that one of its members, Fernando Martin Vicente, has committed serious errors that have damaged the Paralympic movement and we are therefore determined to take tough measures within the next 17 days to root out the cause of the problems."
The committee began its investigations at the end of November following allegations by Carlos Ribagorda, a member of the team. He accused the nation's Paralympic team organisers of selecting athletes with no handicaps in order to win medals.
Ribagorda, a journalist, said he had played for the basketball team for more than two years but had no mental handicap. He also said that he and nine team mates were not subjected to any tests to check their eligibility.
"Of the 200 Spanish athletes at Sydney at least 15 had no type of physical or mental handicap. They didn't even pass medical or psychological tests," Ribagorda said in an article published last month in the magazine Capital.
"The FEDDI did not hesitate in signing up athletes without any type of handicap.
"They just sent them an official letter...The aim of this policy was to win medals and gain more sponsorship. The FEDDI discovered that it could benefit from signing up athletes who had no physical or mental handicap."
The Sydney Games were Spain's most successful Paralympics. The team won 107 medals and finished third in the medals table behind Australia and Britain.
Reuters
Spain's Paralympic basketball team will hand back gold medals won at the Sydney Games after 10 of their players were found to have no disability, officials have said.
