Campaigners said the decision is damaging to the well-being of children with trans parents and discriminatory to the community as a whole.
The woman, who cannot be identified, changed her sex in 2012 and has been in a registered civil partnership since September 2015.
A child was born to the couple in June 2015.
Germany's Federal Court of Justice ruled against the woman's request to be legally recognised as a mother, arguing that the country's gender identity law Transsexuellengesetz states that change in gender does not alter the legal relationship between a parent and child, even in cases when the child was born after transition.
"The legal parent of the child is only the woman who gave birth to the child," the court said in a statement.
Sascha Rewald, from the working group on parenthood with campaign group Bundesvereinigung Trans, told The Independent he was disappointed with the decision as it was not in the child's best interests.
"With this conservative decision, the Federal Court is again disregarding the day-to-day reality of children of trans persons, and approves their discrimination," he said.
"With the new decision and with birth certificates on which one of the two mothers is named as a father with her dead name, the concerned children are exposed to continued discrimination in the kindergarten, at school or their free time. This cannot be in the interest and benefit of the child's well-being.
"Furthermore, this decision is not up to date. With the elimination of the requirement of sterilisation for legal gender recognition by the Constitutional Court in 2011, the German law allows pregnant fathers and procreating mothers. The legislator has missed the opportunity to recognise the reality of these families and to establish legal regulations. This has to finally happen."
Bundesvereinigung Trans, itself an umbrella organisation for smaller trans groups throughout Germany, is now calling for the law to allow trans parents to be listed as gender-neutral on their children's birth certificate with their chosen name. It also wants Transsexuellengesetz to be abolished and replaced with a new gender recognition law similar to countries like Malta and Argentina.
Although Germany is more progressive than some countries when it comes to its LGBT+ citizens, this is not the first time the courts have been accused of discrimination when it comes to issues of gender.
In September 2017, the Federal Court of Justice denied a request by transgender man Oscar Müller to be registered as the father of the child he conceived in 2013.
Mr Müller legally transitioned in 2011 and became pregnant through artificial insemination using a sperm donor. After his son was born, the birth registry refused to recognise Mr Müller as a father and entered him as a mother on the birth certificate, using his female birth name.
However, in November, the Constitutional Court ruled in favour of introducing a third gender category for people who do not identify as male or female, saying that the previous law on civil status was discriminatory towards intersex people.
Steve Taylor, a spokesperson for the European branch of the International Lesbian, Gay, Bisexual, Trans and Intersex Association (ILGA-Europe) echoed calls for legislators to update their practices and be more inclusive towards the 100,000 transgender people estimated to be living in Germany.
"Germany’s Transsexuellengesetz dates back to 1981, and while progressive at the time didn’t consider the possibility of trans people producing genetic offspring, and so the law doesn’t cover this," he told The Independent.
"This isn’t the first time that a trans parent has brought a case to the German courts, and we would like to see Germany legislate to make the situation clearer for everyone and fair for trans parents and their children.
“Germany currently ranks 13th in our Rainbow Europe index of LGBT+ equality in Europe, and greater efforts at ensuring equality for trans people, including for trans parents, would help to improve Germany’s place in this list.”
The UK's Gender Recognition Act is similar to Germany's Transsexuellengesetz.
It states: "The fact that a person’s gender has become the acquired gender under this Act does not affect the status of the person as the father or mother of a child."
However, Michelle Brewer, a barrister for Garden Court Chambers who also works with advocacy group Trans Equality Legal Initiative, told The Independent this is yet to be tested in the courts.
"There was a High Court case in the UK where a child had been born to a couple prior to transition and legal recognition of one of the parents," she said. "The parent who was a trans woman sought to have the child's birth certificate amended retrospectively - namely to identify her not as the father but as the parent. The Court ruled that it was not a violation of the European Convention on Human Rights to deny the amendment to the birth certificate."
The core provision of the Gender Recognition Act is once you have legal recognition of your gender, you must be treated for all purposes as that gender, which Ms Brewer said should "arguably" be reflected in parental titles.
"I disagreed in the High Court judgement as it does not reflect how, for instance, family courts have emphasised the importance of a child's 'life story' being a true reflection of their status.
"So if a child's 'life story' is that she is being raised by two mothers and in her social, private and public interactions that is how her 'life story' presents, then to have a birth certificate that does not reflect this I think gives rise to significant concerns - particularly given the rise in transphobic crime and discrimination which could trickle down to the child."
The Gender Recognition Act was due to be reviewed by the government at the start of this year but has been delayed until Spring at the earliest.