The 45-year-old, who also has a wildcard for the grand slam which begins on Sunday, was outpointed 6-4 6-3 by 38-year-old German sixth seed Tatjana Maria.
In front of a packed main court crowd, seven-time major winner Williams had her moments and broke serve to level in the second set before Maria closed it out.
A seven-time major winner, Williams will become the oldest woman in the main draw of the Australian Open, breaking a mark set by 44-year-old Kimiko Date in 2015.
Williams, who has battled injury and health problems in recent years and is ranked 576, last played at Melbourne Park in 2021.
She made the final in 2003 and 2017, losing to sister Serena both times.
Earlier on Tuesday, dual grand slam winner Barbora Krejcikova's Australian Open preparations hit a bump when she suffered a knee injury flare-up in a first-round loss.
The world No.55, who spent several months of 2025 off the tour with a knee problem, lost 6-4 1-6 7-6 (7-4) to No.67 American Peyton Stearns.
Krejcikova had a medical timeout for treatment on her knee at the end of the first set after pulling up sore.
She played on after having it re-strapped but at times appeared hampered with her movement.
The 30-year-old played three matches in the United Cup last week, picking up two wins including over top-ranked Australian Maya Joint.
Krejcikova, who won the French Open in 2021 and Wimbledon in 2024, missed last year's Australian Open with a back injury.
She didn't answer questions about her knee post-game but said she was looking forward to the Australian Open, which begins on Sunday.
"I think I've played the most matches I've ever played at the beginning of a year. So I'm really happy with that," she said.
Stearns will meet Olga Danilovic in the second round after the unseeded Serbian beat defending champion and second seed McCartney Kessler on Monday night in three sets .
In other round one results on Tuesday, Slovakia's Rebecca Sramkova toppled Frenchwoman Varvara Gracheva to set up a second-round match with Australian wildcard Taylah Preston.
The 20-year-old scored a sizeable upset on Monday, beating world No.40 Jessica Bouzas Maneiro in straight sets.
Third-seed Iva Jovic cruised past Indonesia's Janice Tjen 6-0 6-1 in less than an hour, while Bulgaria's Anna Bondar made light work of lucky loser Ella Seidel 6-0 6-1.
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