Brendan Rodgers' men knew only a victory would suffice at Selhurst Park after City, who now sit one point behind Liverpool with a game in hand, edged to a seemingly crucial 3-2 triumph at Everton on Saturday. That result left City, who wrap up their season with home games versus Aston Villa and West Ham this week, at the summit thanks to goal difference.
And for large parts of the game against Palace, it appeared merely a question of how much Liverpool could eat into City's nine-goal lead after Daniel Sturridge and Luis Suarez added to Joe Allen's first league goal for the club.
But having been cruising at 3-0 after 55 minutes, Liverpool had to endure a chastening finish as Damien Delaney's 79th-minute deflected strike was immediately added to when Dwight Gayle capped a smart counter-attack with a cool finish two minutes later.
Liverpool tried desperately to defend, but were hit with a sucker-punch with two minutes remaining when Gayle finished powerfully.
An incredible finish at Palace has left Liverpool, who end the season at home against Newcastle United on Sunday, hoping that Villa and West Ham can do them favour to revive their hopes of landing a first top-flight title since 1990.
Liverpool began in typically quick fashion and had a strong penalty appeal turned down after Glen Johnson went down under a clumsy challenge from Yannick Bolasie.
Undeterred, the visitors continued to press forward and almost took the lead in the 16th minute. Allen delivered a glorious ball over the centre-halves but Johnson, having made a fine diagonal run behind Joel Ward, nodded just over the crossbar.
Palace were to rue their failure to heed the lesson from Steven Gerrard's first corner as they conceded via a set-piece for the first time under Tony Pulis two minutes later.
Allen was the beneficiary of some lacklustre defending, marking his 50th league appearance for Liverpool by nodding across Julian Speroni and into the net having found space at the back post with a clever run.
Jason Puncheon forced a good save from Simon Mignolet with a powerful effort from distance. The Belgian goalkeeper had to be on a high alert again moments later, producing an even better save when turning Mile Jedinak's thunderbolt over.
Any momentum Pulis' men had built before the break was quickly extinguished afterwards as Liverpool attacked with verve.
Sturridge was the main threat, seeing an effort tipped on to the post by Speroni before strike partner Suarez, rumoured to be playing despite illness and having added the Football Writers' Player of the Year award to the PFA gong earlier in the day, uncharacteristically fired over with the goal gaping.
However, Sturridge doubled the advantage moments later, his deflected effort trickling beyond Speroni. Suarez soon got in on the act, sliding coolly under the goalkeeper following a fine one-two with Raheem Sterling.
Liverpool piled forward with similar intent thereafter, yet quickly found themselves defending for their lives as Palace flipped the narrative.
Delaney was the first to strike, his pot-shot taking a wicked deflection and beating Mignolet. Suddenly Palace had hope, which was only added to as Bolasie surged forward on the break and slid in Gayle - who made no mistake.
And the former Peterborough United man was not finished there, breaking Liverpool hearts with a thunderous left-footed strike.
Both sides tried for an unlikely winner without avail, meaning Liverpool now require a City slip-up and victory on Sunday to have any hope of lifting the Premier League title.
