Luigi Brugnaro, who owns an employment agency, came first against the Poveglia Association with an offer of 513,000 euros ($704,000) against the local community group's offer of 160,000 euros for the 99-year lease.
Brugnaro's spokesman Alvise Sperandio said the businessman had not yet decided what exactly to do with the island but would ensure its "public use" and invest 20 million euros to restore derelict buildings.
"He wanted to do it for Venetians to stop the Arabs or the Chinese from buying it for themselves," he said, adding that the businessman would hold consultations with Venice's mayor and the community on what to do.
But Lorenzo Pesola, a spokesman for the Poveglia Association, said the price offered was "surreal".
"We will insist that the offer is turned down," he said.
The state agency handling the auction has 30 days to accept or turn down the highest offer for the island.
The Poveglia Association managed to crowdfund 440,000 euros from some 4,000 donors, coming just short of being able to offer a higher price than Brugnaro in a second round of bidding.
The 7.5-hectare (18.6-acre) island near the Venice Lido was a quarantine point for ships coming to Venice in the 18th and 19th centuries and also served as a defence post for Venice with an octagonal fort.
It was turned into a mental asylum in the 20th century.
Legend has it that the overgrown island, which is also where Venice's plague victims were kept, is haunted by the tortured souls of those who were buried there.
It has been abandoned since the 1960s and has several dilapidated buildings including a church, a hospital, an asylum, a prison and housing and office buildings.
The Poveglia Association planned to sponsor "a mosaic of economic initiatives" including a sailing school, a cafe and residential archaeology courses.
Pesola said that if Brugnaro's bid is rejected, the association could "manage" the island for the state.
He also did not exclude a possible partnership with Brugnaro but said "the signs are not positive".