Sanchez's proposal was defeated with 219 votes against and 131 in favour, with only his own party, Ciudadanos and a tiny party from the Canary Islands voting in favour. It would have needed more assembly votes in favour than against in order to pass.
His first attempt to win approval on Wednesday - which required an absolute majority of 176 votes in favour, a higher threshold - also fell well short of the mark after an acrimonious debate in parliament that highlighted the country's political divisions.
Spain has been in political limbo since the election which resulted in a hung parliament divided among four main parties - none of which won enough seats to govern alone.
Parties now have until May 2 to negotiate an alternative power-sharing agreement. If they fail, new elections will be called, most likely on June 26.