The UK and EU have agreed on a “large part” of the agreement that will lead to the “orderly withdrawal” of the UK.
Brexit negotiators Michel Barnier and David Davis said the deal on what the UK calls the implementation period was a “decisive step”.
But issues still to be resolved include the Northern Ireland border.
The transitional period is set to last from 29 March, 2019 to December 2020, and is intended to smooth the path to a future permanent relationship.
Mr Barnier said there was also an agreement on the rights of 4.5m EU citizens in the UK and the 1.2m UK citizens in the EU after Brexit, including giving EU citizens arriving in the UK during the transition the same rights and guarantees as those who arrive before Brexit.
The proposed deal will include an emergency “backstop” option to avoid a hard border that could see Northern Ireland effectively staying in parts of the single market and the customs union – a move which Theresa May has opposed.
The UK will also be able to negotiate and sign trade deals during the transition period.
Both the UK and the EU hope the terms of an agreement on the transitional period can be signed off by Mrs May’s fellow leaders at the EU summit this week.