Needing just a draw to reach the quarter-finals, the Australians came unstuck in steamy conditions at Rifu's Miyagi Stadium on Wednesday.
Goals in either half from Ahmed Rayan and Ammar Hamdy were enough for the Egyptians to leapfrog above Australia and Argentina into second spot in Group C with Spain finishing first.
With seven of Graham Arnold's starting XI playing their third game in nine days and Nathaniel Atkinson, Mitch Duke and Riley McGree all suspended, Australia looked leggy in the sapping conditions.
After dominating the first half, the Young Pharaohs got their reward just before the break when Ramadan Sobhi skipped past Harry Souttar and cut back to Rayan, who slammed the ball past Tom Glover.
Needing inspiration, Arnold made a double-change at the break with Daniel Arzani and Keanu Baccus thrown on.
Arzani tested Egyptian keeper Mohamed Elshenawy early in the second stanza as Australia made a strong start to the half.
The dangerous Arzani again forced Elshenawy into a smart save in the 80th minute and from the resulting corner Thomas Deng's goal-bound header was turned past the post by in-form the Egyptian shot-stopper.
The Olyroos were made to rue those saves moments later when Hamdy pounced on a loose ball at the back post to fire the Egyptians into a last-eight showdown with defending Olympic champions Brazil.
Despite the exit, Arnold said there were plenty of positives for his team to take away from the tournament including their famous opening 2-0 win over Argentina.
"These boys will go home with the fantastic memories of beating Argentina, and really pushing Spain the whole way. Did those two games take it out of us?
Maybe, but I couldn't be prouder," Arnold said.
"In the past the Olympics has developed and created a lot of national team players for the Socceroos ... I do feel that I walk away from here with much more depth now for the Socceroos."