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Abstract Background Abnormal lipid accumulation has been recognized as a key element of immune dysregulation in microglia whose dysfunction contributes to neurodegenerative diseases. Microglia play essential roles in the clearance of lipid-rich cellular debris upon myelin damage or demyelination, a common pathogenic event in neuronal disorders. Apolipoprotein E (apoE) plays a pivotal role in brain lipid homeostasis; however, the apoE isoform-dependent mechanisms regulating microglial response upon demyelination remain unclear. Methods To determine how apoE isoforms impact microglial response to myelin damage, 2-month-old apoE2-, apoE3-, and apoE4-targeted replacement (TR) mice were fed with normal diet (CTL) or 0.2% cuprizone (CPZ) diet for four weeks to induce demyelination in the brain. To examine the effects on subsequent remyelination, the cuprizone diet was switched back to regular chow for an additional two weeks. After treatment, brains were collected and subjected to immunohistochemical and biochemical analyses to assess the myelination status, microglial responses, and their capacity for myelin debris clearance. Bulk RNA sequencing was performed on the corpus callosum (CC) to address the molecular mechanisms underpinning apoE-mediated microglial activation upon demyelination. Results We demonstrate dramatic isoform-dependent differences in the activation and function of microglia upon cuprizone-induced demyelination. ApoE2 microglia were hyperactive and more efficient in clearing lipid-rich myelin debris, whereas apoE4 microglia displayed a less activated phenotype with reduced clearance efficiency, compared with apoE3 microglia. Transcriptomic profiling revealed that key molecules known to modulate microglial functions had differential expression patterns in an apoE isoform-dependent manner. Importantly, apoE4 microglia had excessive buildup of lipid droplets, consistent with an impairment in lipid metabolism, whereas apoE2 microglia displayed a superior ability to metabolize myelin enriched lipids. Further, apoE2-TR mice had a greater extent of remyelination; whereas remyelination was compromised in apoE4-TR mice. Conclusions Our findings provide critical mechanistic insights into how apoE isoforms differentially regulate microglial function and the maintenance of myelin dynamics, which may inform novel therapeutic avenues for targeting microglial dysfunctions in neurodegenerative diseases.