The Palestinians were shot in an early morning raid on Rafah's Yibna refugee camp, located along Gaza's border with Egypt.
Israeli Apache helicopters, backed by tanks and bulldozers, fired three missiles at a residential quarter of the camp, killing Muhammad Abu al-Nada, 18, Masira Abu Sanima, 19, and 31-year-old Akram al-Habibi in the process.
Two of the bodies were badly burned and decapitated, say witnesses. Aljazeera correspondent Hiba Akila said the three dead were members of Hamas's military wing, Izz al-Din al-Qassam Brigades.
Seventeen bystanders, including Reuters cameraman Bassam Masud, were injured in the attack, according to Dr Ali Musa, director of the Abu Yusuf al-Najjar Hospital in Rafah.
The Israeli army denies any involvement in the incident, saying a Palestinian bomb that detonated earlier was to blame.
Aljazeera has received a statement issued by Hamas's military wing, Izz al-Din al-Qassam Brigades, claiming responsibility for detonating four explosive devices in four Israeli bulldozers in Yibna.
The movement also fired a rocket-propelled grenade at an Israeli troop carrier, the statement said.
"People are fleeing
their homes; they
are very scared"
UNRWA field officer
More than 15 tanks and bulldozers are continuing to operate in Block O of the camp, according to UNRWA field officer Jamal Hamad.
"People are fleeing their homes; they are very scared," said Hamad.
"There is an ongoing exchange of fire, and Israeli troops are responding with heavy fire and tank shells," he added.
Hamad said tanks had reached as far as the UN clinic, well beyond the border and the centre of town.
During the raid, Israeli occupation army bulldozers also razed to the ground a few hectares of agricultural land and demolished six houses near the border with Egypt.
The UN says Israel has been following a policy of "levelling" and systemically demolishing houses in Rafah to make way for a "security" buffer zone in what has come to be known as the "Philedelphi Corridor". Israel says arms smuggling tunnels are the reason for the demolitions.
Reuters cameraman Masud was
injured in the helicopter attack
Rafah has been the scene of continuous Israeli onslaught since the start of the al-Aqsa intifada in September 2000, the most egregious of which took place in May this year. Fifty-five Palestinians were killed and more than 200 others injured in the attack, and about 3500 were made homeless.
Also in Gaza, Israeli troops for the second night in a row fired heavy artillery at residents near the Tal al-Zaatar neighbourhood in the northern Gaza Strip town of Jabaliya. One Palestinian was treated for shock.
Palestinians in Jabaliya fear Israeli troops are thinking of expanding their month-long siege of neighbouring Bait Hanun, after Israeli officers admitted they had been unsuccessful at preventing the firing of homemade Qassam rockets into Israel by closing off the town.
Those in Bait Hanun have been
besieged for more than a month
The northern Gaza Strip village of 30,000 has been under siege since 30 June, when Israeli forces launched an incursion with the stated aim of creating a security zone after rockets fired into the Negev town of Sderot by Palestinian resistance fighters claimed their first fatalities.
Since then, 16 Palestinians have been killed and more than 90 injured, and about 2600 dunums (263 hectares) of agricultural land cleared.