The resolution failed to muster the minimum nine "yes" votes required in the council for adoption.
What does the new draft resolution submitted on December 29 call for?
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.
"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.Palestinian statehood
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.
UN resolution 'not representative' of Palestinians
Israel had said the Security Council vote, following the collapse in April of US-brokered talks on Palestinian statehood, would deepen the conflict.
Ali Abunimah, co-founder of the Electronic Intifada, derided the resolution, telling Al Jazeera it undermined Palestinian rights, including the rights of refugees and the future of Jerusalem.
"This was a terrible resolution which was unaninimously opposed by every major Palestinian faction, it contained so many compromises in an attempt to avoid a US veto that it was weaker than existing UN resolutions," he said.
The Palestinians, frustrated by the lack of progress on peace talks, have sought to internationalise the issue by seeking UN membership and recognition of statehood via membership in international organisations.
Several European parliaments have adopted non-binding motions calling for recognition of Palestine.
The Palestinians had warned that if the UN resolution failed they were prepared to join the International Criminal Court to file suits against Israel.