Uzbek troops have retaken the border town of Korasuv, where locals threw out their leaders last week in a popular protest.
Mr Rakhimov said people could no longer tolerate President Karimov
A number of explosions and some gunfire was heard, but the takeover seems to have been largely peaceful with no reports of loss of life.
The uprising's leader, Bakhtior Rakhimov, who said he intended to build an Islamic state, has been arrested.
The uprising in Korasuv followed a bloody crackdown in nearby Andijan.
Uzbek officials say 169 people died, but an army source told the BBC 500 were killed when troops opened fire on protesters last Friday.
Most populous central Asian former Soviet republic, home to 26m people
Ruled since 1991 independence by autocrat Islam Karimov
Accused by human rights groups of serious abuses, including torture
Rocked by violence in capital Tashkent in 2004
Government says radical Islamic groups behind violence
Hundreds of government forces are said to have arrived in Korasuv overnight.
According to residents, they arrested Mr Rakhimov, a farmer, and several of his employees.
One employee told the BBC there were signs of shooting during the arrest, with a bullet hole in a television.
"People here aren't happy with what's happened. Everyone is sorry that Bakhtior has been arrested and that they won't let people hold meetings. What can people do?" the employee said.
In Korasuv, local people are being allowed to cross the newly constructed bridge to Kyrgyzstan. But journalists are no longer being allowed to cross, according to the BBC's Ian MacWilliam, who is on the Kyrgyz side.
The residents of Korasuv - which has a population of about 20,000 - drove out police and officials last Saturday, and were reportedly in control of the town until troops took it back on Wednesday night.
Mr Rakhimov told our correspondent on Wednesday that the people in the region had put up with President Islam Karimov for 16 years, and could no longer tolerate him.
Residents said the main cause of resentment was the lack of work combined with the regime's tough curbs on private trade.
He said that the townspeople wanted to establish an Islamic administration in the area, but he did not elaborate on the aspiration, or whether the town had any connections to the wider Islamic separatist movement thought to operate in the area.
The local takeover of Korasuv on Saturday was triggered by the bloody crackdown of protesters in the town of Andijan the day before.
The unrest began when a group of men stormed the town's prison and freed 23 businessmen accused of being Islamic extremists.
These men joined a large protest, which correspondents say was also fuelled by long-term frustration over poverty and unemployment.
Locals say troops then fired indiscriminately into the crowd.
The authorities say no civilians were killed, only Islamic militants who had organised the protest.
President Karimov's repressive regime has come under increasing international pressure in the wake of the incident.
On Wednesday night, US Presidential spokesman Scott McClellan re-iterated American calls for "a more open and responsive government".
Both United Nations Human Rights Commissioner Louise Arbour and the British Foreign Secretary Jack Straw also called for an inquiry into the incident.
But Mr Karimov does not liked to be pushed around and according to the BBC's Ian MacWilliam, the takeover of Korasuv could well be his response to his foreign detractors.