Andretti Autosport driver, Sato, took the lead in the closing stages as he edged three-time Indy 500 winner Helio Castroneves of Team Penske into second.
"It's an unbelievable feeling," Sato said after the race. "I can't thank enough this team. Hopefully the crowd enjoyed it."
"With three laps to go I really didn't know but I just knew I had to go for it," the 40-year-old added.
Castroneves was gracious in defeat, heaping praise on race winner Sato whose only previous Indycar victory came at the 2013 Long Beach Grand Prix.
"You guys saw, it was a little too hard for me today. Congrats to Takuma Sato," Castroneves told ESPN.
"I really tried hard. I think I bent the throttle pedal, I was pushing that hard," the Brazilain driver added.
At the point he was forced out of the race, Alonso held the fastest average lap time in his own Andretti Autosport car.
Yet the irony of mechanical trouble putting an end to his hopes will not be lost on the Spaniard who has suffered a his fair share of vehicle problems at McLaren in recent years.
Alonso had earlier passed on a message of good luck to F1 teammate Jenson Button as he prepared to take to the track at the Monaco Grand Prix
But While Button was rarely competitive on the Mediterranean coast, retiring after a collision with Pascal Wehrlein, Alonso was most definitely in the mix some 4,500 miles away.
The two-time F1 champion hit the front for the first time after 37 laps before passing the baton to teammate and 2016 winner at the Indy 500, Alexander Rossi.
Airborne in flames
A spectacular crash between Jay Howard and Scott Dixon saw the race halted just as the two-time F1 champion appeared to be getting into a groove up top.
Howard clipped the wall and bounced down into Dixon's path, sending him airborne with flames firing out the back of the car before crashing into the side wall.
Incredibly, neither Dixon or Howard suffered injury in the incident.
Alonso, Rossi and fellow Andretti teammate Ryan Hunter-Reay were soon jostling for position alongside Castroneves as the group the passed the lead around.
Yet engine trouble saw Hunter-Reay forced out after 138 laps and Alonso dropped down the field after pitting.
That allowed Max Chilton of Chip Ganassi Racing to slip into top spot before Alonso was forced to retire.
Alonso was given a rousing reception by the 300,000-strong Indianapolis crowd who seemed impressed by his exploits.
He later told ESPN he felt it was unfortunate the way things had turned out but that racing at Indianapolis had been "one of the best experiences of my career."
Andretti Autosport chief Mario Andretti, meanwhile, was quick to offer his consolations to Alonso, tweeting that he had "put on an incredible show."
Out on the track, however, the drama was just beginning.
A four car pile-up ensued down the field as the race restarted with Oriol Silva losing control and taking James Davison, Josef Newgarden, James Hinchcliffeand Will Power with him.
When the track was finally cleared of debris there was just 13 laps to go.
Chilton was overtaken first Castroneves and then by Sato. And with the checkered flag fast approaching Sato made one final dash around Castroneves.
It was a move that ensured a Japanese driver would rein supreme at the Indy 500 for the first time in it's 101 editions.