In a surprise division at the end of a short debate, cross-bencher Lord Henderson of Brompton announced that his motion calling for the reform had been carried by 126 to 108.
The defeat came after Lord Henley, from the Government front bench, had warned that the change in the regulations could easily cost some pounds 35m, in addition to the already massive burden on taxpayers and National Insurance contributors.
Last night it was not clear whether the vote would do more than embarrass ministers. Peers on all sides had earlier attacked the Government over the 'inhuman conditions in bed and breakfast accommodation'.
Lord Henderson claimed his move would benefit 12,000 families - about 29,000 people - living in 'squalor'. He alleged that to pay a pounds 10 premium to those in this accommodation where all meals or self-contained facilities for preparing meals was not available, would cost about pounds 15m a year.
Lord Ennals, a former Labour Social Services Secretary, said the number living in this sort of accommodation was increasing and the recession had not helped the situation. It was a tragedy which could not be allowed to continue.
The Liberal Democrat, Lord Beaumont, said: 'The situation is a crying scandal which should not be tolerated.' If the Government adopted the 'minor reform' suggested, it would change 'a terrible and dangerous misery' to one of 'merely tolerable misery'.
Winding up, Lord Henley said: 'Figures for homeless families in London are falling by 18 per cent, compared to last year, and in England numbers in bed and breakfast accommodation have fallen in the last two quarters. It would be a mistake to divert scarce resources into benefits whose effect would be to reverse this trend and return to discredited arrangements of the past.'
Commons: Employment questions; Questions to the Prime Minister. Finance Bill, report. Supplementary estimates vote. Value Added Tax (Payments on Account) Order. Lords: Introduction of Lord Merlyn-Rees (Lab) and Lord Parkinson (C). Civil Service (Management Functions) Bill, committee. Criminal Justice Act (Contracted Out Prisons) Order. Debate on the Social Fund.