Hi Raj,
When you mention the local domain servers, have you deployed Exchange Hybrid environment or Single Sign On for domain1.com and domain2.com?
Generally speaking, if you want to merge a domain into another domain, you need to delete the domain from the tenant first. To delete a domain from Office 365, please refer to the link below:
Remove a domain
After you removed the domain2 and add it into your original tenant, if you also have the local environment for domain2, you can sync users from your local AD. For more detailed information, please refer to the link below:
http://onlinehelp.microsoft.com/en-us/office365-enterprises/ff652543.aspx
Thanks,
Jolin Qiao