26-year-old Rahman, currently lodged in Sabarmati Jail in Ahmedabad and the only candidate in the April 15 polls to contest from prison, was defeated by Congress' sitting councillor Shoib Danish in Zakir Nagar.
Danish polled 8,194 votes while Rahman managed to get 7,677 votes.
Rahman's family and supporters had been campaigning for him in his absence as he was lodged in Ahmedabad jail.
"We are in a state of shock. We lost in areas we were considering our stronger points," Amanutullah Khan, a social worker spearheading his campaign, told PTI.
He said "by the kind of response we got during the campaigning process, we have were assuming that his win will ensure a breather and he will get relief, probably in the form of a parole or a bail, in the blasts cases."
The entry Rahman, who was arrested in the Batla House encounter in September 2008 after the serial blasts, had again brought into ficus the issue of yje controversial gunbattle in which his two alleged associates were killed along with a Delhi Police Inspector.
His entire campaigning was led by his family, which included his 63-year-old father Abdur Rahman, his mother and sister. He also got the support of local MLA Asif Mohammed Khan.