The Gunners came back from four goals down against a game Royals side and triumphed in extra time after a contest which will go down among the classics of the modern era
First half strikes from Jason Roberts, Mikele Leigertwood, Noel Hunt and an own goal from Laurent Koscielny had earlier given the rampant Royals a lead which looked unassailable.
But a double from Walcott - along with efforts from Olivier Giroud and Koscielny in the right end – forced the match to extra time.
Marouane Chamakh edged the Gunners in front, but substitute Pavel Pogrebnyak’s header looked to have sent the game hurtling towards penalties before Walcott and Chamakh struck again to seal the win.
The astounding result gives Arsene Wenger a timely and unlikely boost after last week’s stormy annual general meeting, while his opposite number Brian McDermott now faces a stiff challenge to pick his dejected players up in time for Sunday’s relegation crunch clash against QPR.
Wenger rang the changes from the side which beat QPR on Saturday, resting Jack Wilshere and handing a rare start to youngsters Serge Gnabry and Damian Martinez.
McDermott, meanwhile, fielded a strong side despite having one eye firmly fixed on that crucial trip to Loftus Road on Sunday.
In front of a raucous home crowd, Reading started the brighter, and in the second minute Sean Morrison met Nicky Shorey’s cross with a firm header which struck the post.
Less than 10 minutes later they did take the lead, however, when Roberts met Hal Robson-Kanu’s precise center to nod home from close range.
There was no discernible reaction from Arsenal, and on 18 minutes, the hosts doubled their advantage when Chris Gunter’s cross cannoned off Koscielny and beat Martinez at his near post.
Wenger’s makeshift team looked lost, and three minutes later it was three down when Leigertwood drove to the edge of the box and unleashed a low strike into the bottom corner.
Reading looked nothing like the side which has yet to record a Premier League victory this season, and on 37 minutes Hunt nodded in a fourth from another cross, this time from Garath McCleary.
Spurred on by the humiliation, Arsenal poured forward once more, and in first half injury time Walcott raced onto a rare incisive Andrey Arshavin pass and dinked over Adam Federici to give his side the smallest measure of hope going into the break.
But Reading began the second half as they had ended the first and, moments after Leigertwood had tested Martinez again, the former Crystal Palace man raided down the left and clipped in in a cross which Miquel directed narrowly over his own crossbar.
The Arsenal attack was at least starting to show signs of life, however, and after Leigertwood had spurned another decent chance, Walcott latched onto another Arshavin pass before hitting a left footed effort which was kept out by a mixture of Federici and the post.
Just after the hour Wenger introduced German youngster Thomas Eisfeld and Giroud in place of Serge Gnabry and Emmanuel Frimpong, and the French striker took just seven minutes to make an impact, impressively heading in Walcott’s corner.
Reading began to sense a first ever victory over Arsenal, but the Gunners had other ideas.
Koscielny's 90th minute header set up a frantic finale, before Walcott’s angled shot crossed the line despite Shorey’s best attempts to clear. Carl Jenkinson followed up and smashed in to remove any doubt that this remarkable match was headed for extra time.
Two minutes in the hosts almost retook the lead, McCleary surging through the centre of the pitch before jinking past two Arsenal defenders and forcing Martinez into a decent save low to his right.
But the momentum was now firmly with the Gunners, and two minutes before the interval some good work from Giroud and Arshavin found Chamakh on the edge of the box, and the much-maligned Moroccan fired a low shot through the legs of Kaspar Gorkss and past Federici.
Deflated but not yet defeated, Reading poured forward in the second period and Martinez had to save superbly with his legs to deny a goal-bound Morrison header.
The Royals kept coming and, four minutes from time, they got their reward, as Chris Gunter’s shot was deflected into the path of the newly-introduced Pogrebnyak, who powered a header in.
Play flowed from end to end with both sides desperately searching for a winner, and Arsenal made the breakthrough when Arshavin’s shot was hacked off the line by Gorkss, only for Walcott to hammer home the rebound.
Reading was in no mood to give up, but its fate was sealed with seconds remaining when Chamakh latched onto a clearance and lobbed the despairing Federici to give a truly astonishing match the finish it deserved.