David McGoldrick seemed to have taken the cup tie to extra time when he cancelled out Nicolas Pepe's first-half penalty with less than five minutes to go.
However, in the dying moments of the match, Dani Ceballos slid the ball under Dean Henderson following a counter-attack to ensure Arsenal progressed to the semi-final at Wembley.
Wilder looks for positives
Despite losing the game at such a late stage, Chris Wilder remained upbeat in his post-match press conference.
The Blades have failed to win any of their four games since football restarted on the 17th of June.
"There are encouraging signs," Wilder said.
"It is something we can move on from. It was more of a Sheffield United performance than the previous games
“I think it was a fully committed performance, especially 2nd half; A couple of things have gone against us, John just being half a yard offside, Basham just being a bit anxious in making a challenge.
"The players have not let anyone down."
Wilder looking forward
Sheffield United are next in action on Thursday when they host Tottenham Hotspur at Bramall Lane, in what is a big game for both sides in the race for Europe.
Wilder remains confident that his side can turn things around despite their poor form despite the restart.
“I thought we were bright, energetic. We’ve got so much more quality in our team than we are showing.
"Does that come with a couple of defeats and a little bit of a loss of belief, possibly so? But we back them. It happens when you’re not at your free flowing best.”