Andy, now 17 years old, has outgrown his old toys and is preparing to move to college. He decides to take Woody with him and packs the other toys in a garbage bag, intending to store them in the attic, but Andy's mother mistakenly puts the bag out on the curb as garbage. Believing that Andy no longer wants them, the toys sneak into a box to be donated to Sunnyside Daycare. As the only toy who saw what really happened, Woody tries to clear up the misunderstanding, but the others refuse to listen. The toys are driven to Sunnyside where they receive a warm welcome from the daycare toys, led by Lotso the "Lots-O'-Huggin' Bear." Woody tries to convince the others to return to Andy, but they feel like they would be happier at Sunnyside, so they let him leave without them. The others soon discover the children Lotso assigned them with are too young, and they are innocently abused and tortured. Buzz goes to ask Lotso to transfer them to the older children, but is instead caught by some of the Sunnyside toys and reset to his original, deluded space ranger self.
As he escapes Sunnyside, Woody is found and taken in by a girl from the daycare named Bonnie. Bonnie's toys reveal to Woody the truth about Lotso and Sunnyside: Lotso had once been owned by a child, but snapped after his owner lost and replaced him, so he took over Sunnyside and turned it into an Internment. At the daycare, the others discover that Andy is looking for them when Mrs. Potato Head sees him through her missing eye, which was lost in Andy's room. The toys try to leave but are imprisoned by Lotso and his henchmen, including Buzz in his demo mode. Woody returns to Sunnyside to help his friends break out. They accidentally reset Buzz to his Spanish mode during the escape, after which he joins their side (believing they know where his spaceship is) and begins openly flirting with Jessie. The toys use a garbage chute to reach a dumpster outside the daycare, but Lotso and his henchmen catch them. Woody and Ken convince Big Baby, Lotso's chief enforcer, of Lotso's treachery, so he throws Lotso in the dumpster. However, Lotso pulls Woody into the dumpster just before a garbage truck arrives, forcing the others to rescue him. In the chaos of falling rubbish, Buzz rescues Jessie from being crushed, which results in a broken TV falling on him, resetting him to normal, with no memory of his other modes.
The truck takes the toys to a dump where they are forced onto a conveyor belt for disposal. Woody helps Lotso and the others escape ashredder, but Lotso leaves them to die in an incinerator. As the toys accept their imminent demise and join hands, they are rescued by a giant claw crane operated by the squeeze toy aliens, while Lotso is found by a garbage man and tied to the front of a truck, to his dismay. The toys return to Andy's house on a garbage truck and prepare to be stored in the attic, but Woody decides he and his friends would better serve their purpose elsewhere, he leaves a note to Andy suggesting he donate his toys to Bonnie. Together with Bonnie, Andy plays with his toys one more time before he leaves for college, as Bonnie waves Woody's hand at him in farewell as Andy drives away. As Woody and Buzz and the rest of the toys begin their new life with Bonnie, the camera pans up to the final shot of the film: A bright blue sky, the clouds forming a familiar pattern - the wallpaper seen in Andy's childhood bedroom in the opening scene of the first film.
As the credits roll, another box full of donated toys arrives at the now Lotso-less Sunnyside. Among them is the Emperor Zurg toy from the previous movie. It is revealed that with Lotso gone, the conditions for new arrivals has vastly improved. The toys now take turns putting up with the younger children's abuses rather than forcing a certain group to put up with all of it.
