The AfD executive board held a three-hour telephone conference in which it voted 10-3 to instead impose "disciplinary measures" against Björn Höcke, party chairman in the central state of Thuringia, sources told German media.
Amid an internal power struggle ahead of a September general election, AfD leader Frauke Petry had called Höcke a "burden on the party" last week after his address in which he condemned the sprawling Holocaust memorial as a "monument of shame in the heart of the capital".
"We need nothing less than a 180-degree shift in the politics of remembrance," he added in the remarks last Tuesday in Dresden to chants of "Germany, Germany".
Höcke's comments met with an instant uproar, with Social Democrat vice chief Ralf Stegner accusing him of making a "hate incitement speech" - which is illegal in Germany - that called for history to be rewritten.
Germany's Central Council of Jews also expressed outrage, saying Höcke was trampling on the memory of six million Jewish Holocaust victims murdered by the Nazis.
But AfD deputy chief Alexander Gauland, who like Höcke belongs to the hard nationalist wing of the party, defended the politician, telling national news agency DPA that he had "in no manner criticized the remembrance of the Holocaust".
The AfD started out in 2013 as an anti-euro party, but has since morphed into an anti-immigration outfit railing against Chancellor Angela Merkel's liberal refugee policy which brought some 890,000 refugees to Germany in 2015 alone.
The party, which also disputes the place of Islam in Germany, is polling nationwide at around 12 to 15 percent ahead of a general election on September 24th.
A poll on Sunday in the Bild am Sonntag newspaper showed that 61 percent of Germans believed Höcke should be kicked out of the AfD for his speech.