Of course, Madrid knows that he is getting old and will leave the club very soon which made them not interested in keeping him. Maybe, his nature is that he loses this season and wins title the next season, but they are somehow not comfortable with him coaching the club anymore. This was why they brought a younger coach who can spend more time to work and solidify the team so that the trophies will keep on coming in.
Real Madrid are also considering Xabi Alonso as a coach for a long-term project and this is a good momentum for Real Madrid itself to make a change.
Ancelotti has given his best for Real Madrid and maybe needs a refresh as one of the methods to change the team to be better in the long term.
Real Madrid lost all the trophies last season and this is not so ideal for a big team like Real Madrid so bringing in a new coach is a must that needs to be done.
I am sure Xabi Alonso can give his best even though in his first season he fails to bring Real Madrid to win the Champions League because it does take time to change the team according to the playing pattern that he expects.