The 23-year-old has struggled to make an impact in his three years at Anfield, making just six Barclays Premier League starts in his 24 appearances for the Reds.
But Black Cats boss Gus Poyet believes he can get the best out of his fellow Uruguayan and has secured him until the end of the current campaign.
A short Sunderland statement read: "Defender Sebastian Coates has joined Sunderland on a season-long loan from Liverpool.
"The 23-year-old Uruguay international is the Black Cats' eighth summer signing.
"Coates arrived in England in 2011 from Nacional and made 24 appearances for Liverpool, before returning to Nacional on loan last season."
Coates' signing ends for good the fading prospect of a loan return for Fabio Borini, with Premier League clubs only permitted to loan each other a maximum of one player.
Borini's apparent reluctance to return to Wearside alerted interest elsewhere, with QPR having a bid accepted by Liverpool.
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The arrival of Coates represented the second piece of business at the Stadium of Light, with French defender Modibo Diakite having earlier left the club by mutual consent.
The Black Cats confirmed Diakite's exit in a one-line statement on their official website.
Diakite was signed on a free transfer from Lazio last summer but fell out of favour with boss Gus Poyet, making only eight appearances for the club.
The 27-year-old is reportedly lining up a return to Serie A with Fiorentina favourites for his signature.
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