According to police, at about 9am (0400 GMT) on Tuesday four armed men tried to enter the house of a member of the Communist Party of India, Mohammad Yousuf Tarigami, in Tulsibagh, Srinagar, the summer capital of Indian-administered Kashmir.
But after being challenged by Indian soldiers, they barged into the neighbouring house of Ghulam Nabi Lone and killed him, the Press Trust of India (PTI) news agency reported.
Lone was the minister of education and head of the Peoples' Democratic Party.
Police Superintendent Munir Khan said Indian army forces were exchanging fire with the armed men who were in the house after Lone was shot.
Amid the standoff, the al-Mansoorian group is said to have claimed responsibility for the attack, according to the PTI news agency.
Tarigami escaped, but one of his security guards was killed.
One of the armed men was killed during the fighting at Lone's house, Khan said, adding that Lone died while being taken to hospital.
Police said one of the armed men fled, but they had cordoned off the area and a search operation was under way. The bomb squad had also been called in for assistance, PTI reported.
Indian-administered Kashmir's finance minister, Muzaffar Baig, blamed the attack on "rogue elements" within one of the movements fighting for Kashmiri independence.
There was no immediate response from India's federal government.
A two-year peace process between India and Pakistan has eased tensions, but Kashmir remains heavily militarised.