"There are about 100 police here and the whole area is completely closed off," said Assaf Sharon, an activist with the Sheikh Jarrah Solidarity Movement, an Israeli-Palestinian group which fights to stop settlers from taking over Arab homes in east Jerusalem.
"In effect, they are building a new settlement in east Jerusalem," he told AFP.
Faadi Kara'in, 21, told AFP his uncle had sold the three-storey property for 450,000 dollars (333,000 euros), but the family had been trying to fight the sale in court.
"We lost," he said. "In court, they said they had paid half of the money to my uncle Ali, and they wanted to pay the rest to us, but we refused."
Ali Kara'in died three months ago of a heart attack, he said.
Sharon said the Kara'in family had been locked in a legal battle over the property with the right-wing Elad movement, which pushes Jewish settlement in mainly Arab east Jerusalem.
"We saw people from Elad inside the house coordinating things. They seemed heavily involved."
A spokesman for Elad denied it had acquired the property and directed AFP towards Jerusalem-based lawyer Boaz Fiel, who said the property had been purchased by his client Lowell Investments Ltd more than five years ago.
"The company is the owner of the building," he said, describing the firm only as a "foreign company."
"The building was purchased more than five years ago from its lawful owner," he said, without confirming the price.
Although Elad "was not a party to the legal procedures" it had helped Lowell Investments carry out the transaction and the legal issues, he said.
Fiel told AFP the company, which has been involved in a number of recent acquisitions in east Jerusalem, was likely to either rent out the property or sell it on to a third party.
Legal documents show Lowell Investments has been locked in a legal dispute with various members of the Kara'in family since 2004.
Around 2,000 hardline settlers live in the middle of Palestinian neighbourhoods in east Jerusalem.
The exact number of properties owned by the settlers is unclear. Palestinian opposition to building sales to Jewish groups means that deals are often done secretly through middle men.
The Palestinians regard east Jerusalem as the capital of their promised state and fiercely oppose any attempts to extend Israeli control over it.
Israel captured east Jerusalem in the 1967 Six-Day War and later annexed it in a move never recognised by the rest of the world. The Jewish state considers the whole of Jerusalem its "eternal and indivisible" capital.
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