In the present study, we investigated the effect of vacuum annealing on the structural and optical properties of sol–gel dip-coated thin films of Zn$_{0.75}$Mg$_{0.25}$O alloy. XRD studies revealed that all these films werepolycrystalline with hexagonal wurtzite structure and there was no trace of additional phases other than ZnO.With increase in annealing temperature, the samples showed preferred orientation along the c-axis, (0 0 2) plane andalso peak narrowing and peak shift towards higher angles. The calculated values of mean crystallite size increased with annealing temperature indicating the improvement in crystallinity. Heat treatment caused lattice contractionand a decrease in film thickness. The optical transmittance in the visible spectral range enhanced with increase in annealing temperature while the fundamental absorption edge in the near ultra-violet region got red-shifted with annealing. The calculated values of optical energy gap of the samples showed a decrease with heat treatment due to the improvement in crystallinity during annealing and hence the subsequent decrease in quantum size effect.