The AFL's decision would also stop the Swans from luring restricted or unrestricted free agents before the end of 2017.
It means they can only bring in draft picks for players wanting to be traded, like young forward Tim Membrey, who is currently looking to move on.
The Swans can also bring in delisted free agents and upgrade existing rookies.
Following AFL Commission discussions last month, the League wrote to the Swans and told them should they choose to pursue free agents, or trade a player in, COLA payments would cease immediately.
Currently, COLA will be phased out and replaced in 2017 by a rent subsidy scheme.
However, Greater Western Sydney - which also benefits from COLA - will not be under the same restrictions for 2015 and 2016.
An AFL statement said GWS would be exempt because of "TPP (total player payment) position, list structure, (and) contractual commitments".
They will receive $800,000 in 2015 and $600,000 in 2016 under the COLA allowance.
"The Commission stated that the key principle was that the Sydney Swans should use the COLA transition amount to honour existing contracts and not to attract players from other clubs or use that transitional amount to compete with other clubs for the services of players not on their list," the statement said.
"Accordingly, the AFL advised the Sydney Swans last week that the transitional amounts will decrease to zero if the Swans contract a player for their Primary List for either of the 2015 or 2016 seasons who is not currently on their Primary List or Rookie List."
Swans chief executive Andrew Ireland said the club was extremely disappointed.
“As you’d expect, the club is very disappointed and we don’t understand why the AFL has made this rule specifically for us considering we’ve complied with their rules,” Ireland said.
“While we wholeheartedly believe players should receive the cost of living allowance due to the higher cost of living in Sydney, it was ultimately the AFL’s rule, it wasn’t optional and therefore we included it in every player’s contract.
“It doesn’t make any sense that we’re being punished for something that we’ve been told to do.
“It also doesn’t seem fair that we can lose players yet we’re unable to replace them.
“The only reason we’ve been able to recruit players in previous years is by creating salary cap room as a result of players departing the club, which is exactly the same as every other club.
“We’ll continue to discuss the restrictions in place with the AFL administration and Commission.”
“As you’d expect, the club is very disappointed and we don’t understand why the AFL has made this rule specifically for us considering we’ve complied with their rules,” Ireland said.
“While we wholeheartedly believe players should receive the cost of living allowance due to the higher cost of living in Sydney, it was ultimately the AFL’s rule, it wasn’t optional and therefore we included it in every player’s contract.
“It doesn’t make any sense that we’re being punished for something that we’ve been told to do.
“It also doesn’t seem fair that we can lose players yet we’re unable to replace them.
“The only reason we’ve been able to recruit players in previous years is by creating salary cap room as a result of players departing the club, which is exactly the same as every other club.
“We’ll continue to discuss the restrictions in place with the AFL administration and Commission.”
