The FUEL card headliner saw both men trade and dodge heavy strikes before the Brazilian suddenly switched the tempo during the penultimate period of the five-round championship match with an arm triangle choke which McDonald, after grappling against for a while, could not withstand.
Barao's record moves to 32-1 and he could be paired with Dominick Cruz in a huge bantam contest next. The 22-year-old American McDonald suffered only his second defeat and despite the setback which leaves him 15-2, big things are expected from 'Mayday' down the line.
"The fight was great," Barao said. "McDonald is a good fighter and I'm pleased with the result.
"I knew he would be a tough opponent. I felt great coming into the fight, very confident with myself and with my team and I had great expectations."
In the chief support bout, Cub Swanson took a unanimous decision win over Dustin Poirier in a hard-hitting contest which moves the Albuquerque featherweight to 19-5.
American-born Londoner Jimi Manuwa was a popular winner in his light-heavyweight fight with Cyrille Diabate though the retirement of the Frenchman from his corner after round one due to a foot injury was a disappointment.
Exciting prospect Gunnar Nelson remained undefeated with a unanimous welterweight decision over Jorge Santiago, who despite being tired and hurt in the final round managed to survive and became the first victim of the Icelander to go the distance.
Australia's James Te Huna came back from a tough opening round to outpoint Canada's Ryan Jimmo while England's own Che Mills fell to the grounded strategy of Matthew Riddle over the distance.
Six English fighters competed in six preliminary card contests against foreign opposition and finished with four wins and two defeats. The highlight was the charismatic Tom 'Kong' Watson handing Bulgaria's Stanislav Nedkov his first defeat via second-round stoppage with a knee to the midsection and follow-up strikes.
The Southampton fighter earned £100,000 in bonus money for winning the fight of the night and earning knockout of the night, both worth £50,000 apiece.
Portsmouth's Phil Harris defeated American Ulysses Gomez, Birmingham's Vaughan Lee saw off Japan's Motonobu Tezuka and Sunderland's Andy Ogle triumphed over Josh Grispi of the US, all via decision.
But in the final two bouts before the main card, Paul Sass - who trained with boxer Ricky Hatton in the weeks building up to the fight - saw his submissions countered well by Danny Castillo en route to a defeat on the scorecards, as did Terry Etim up against Brazilian Renee Forte.