It came days after a friendship with Epstein landed the former Prince Andrew in police custody.
The Metropolitan Police said early on Tuesday that "a 72-year-old man arrested on suspicion of misconduct in public office has been released on bail pending further investigation".
The man was not named, in keeping with British police practice, but the suspect in the case previously was identified as the former diplomat, who is 72.
Mandelson was filmed being led from his London home to a car by plainclothes officers on Monday afternoon.
Both Mandelson and Andrew Mountbatten-Windsor, the former prince Andrew, are suspected of improperly passing UK government information to the disgraced US financier, and the high-profile British arrests are some of the most dramatic fallout from the trove of more than three million pages of Epstein-related documents released in January by the US Justice Department.
Police are investigating Mandelson over claims he passed sensitive government information to Epstein a decade and a half ago.
He does not face allegations of sexual misconduct.
His arrest came four days after Mountbatten-Windsor was arrested in a separate case on suspicion of a similar offence related to his friendship with Epstein.
He was released after 11 hours in custody while the police investigation continues.
Mandelson served in senior government roles under previous Labour governments and was UK ambassador to Washington until Prime Minister Keir Starmer fired him in September after emails were published showing that he maintained a friendship with Epstein after the financier's 2008 conviction for sex offences involving a minor.
The files released in January contained more explosive revelations about Mandelson's ties to Epstein, whom he once called "my best pal".
Messages suggest that Mandelson passed on sensitive - and potentially market-moving - government information to Epstein in 2009, when Mandelson was a senior minister in the British government.
That includes an internal government report discussing ways the UK could raise money after the 2008 global financial crisis, including by selling off government assets.
Mandelson also appears to have told Epstein he would lobby other members of the government to reduce a tax on bankers' bonuses.
British police launched a criminal probe earlier in February and searched Mandelson's two houses in London and western England.
The decision to appoint Mandelson nearly cost Starmer his job earlier in February as questions swirled around his judgment about someone who has flirted with controversy during a decades-long political career.
Though he acknowledged he made a mistake and apologised to victims of Epstein, Starmer's position remains precarious.
His future may rest on the release of files connected to Mandelson's appointment, which the government pledged to begin releasing in early March.
Mandelson has been a major, if contentious, figure in the centre-left Labour Party for decades, whose mastery of political intrigue earned him the nickname "Prince of Darkness".
He was an architect of the party's return to power in 1997 as centrist, modernising "New Labour" under Prime Minister Tony Blair.
Mandelson served in senior government posts under Blair between 1997 and 2001, and under prime minister Gordon Brown from 2008 to 2010.
In between, he was the European Union's trade commissioner.
Earlier in February, Mandelson resigned from the House of Lords, to which he was appointed for life in 2008.
But he still has the title - Lord Mandelson - that went with it.
