The resolution failed to muster the minimum nine "yes" votes required in the council for adoption.
The motion received eight "yes" votes, including from Russia and France, two "no" votes from the United States and Australia, and five abstentions.
Riyad Mansour, Palestinian ambassador to the UN, criticised the world body for the failure of the vote, Al Jazeera reported.
"The Security Council has once again failed to uphold its charter duties to address this crises and to meaningfully contribute to a lasting solution in accordance with its own resolutions," Mansour said.
"This year, our people under Israeli occupation endured the further theft and colonisation of their land, the demolition of their homes, daily military raids, arrests and detention of thousands of civilians including children, rampant settler terrorism, constant affronts to their human dignity and repeated incursions at our holiest sites."
Following the vote, the US, Israel's closest ally, reiterated its opposition to the draft resolution.
Samantha Power, the US ambassador to the UN, said the resolution undermined efforts to "achieve two states for two people".
"It is deeply imbalanced and contains many elements that are not conducive to negotiations between the parties including unconstructive deadlines that take no account for Israelis legitimate security concerns," she said.
The resolution, which was submitted by Jordan - currently the only Arab member of the security council -had called for occupied East Jerusalem to be the capital of Palestine, an end to Israeli settlement building and settling the issue of Palestinian prisoner releases.
The resolution also called for negotiations to be based on territorial lines that existed before Israel captured the West Bank, East Jerusalem and the Gaza Strip in 1967.