Israel said the move was in response to a bombing that killed nine civilians in a Tel Aviv restaurant on Monday.
One of the politicians threatened to challenge the decision in court.
The bombing was carried out by the Islamic Jihad group, but the Palestinians' new Hamas-led government defended the attack as a justified response to Israeli military strikes.
Ehud Olmert, the interim Israeli prime minister, and Cabinet ministers decided on Tuesday to hold Hamas responsible for the attack.
In one of a list of measures, all Hamas lawmakers who live in Jerusalem will have their residency rights in the city revoked, participants in the meeting said.
Three Hamas MPs have Jerusalem residence permits.
Israel maintains control of access to Jerusalem, including the occupied Arab eastern sector that it captured in the 1967 war and later annexed.
The residency permits are highly prized by Palestinians, because they grant them access to the city, the economic, religious and social centre of Palestinian life that they claim as their future capital.
The revocation is considered an especially harsh punishment that has only rarely been used against Palestinians.
Without the permits, the three lawmakers are likely to be forced out of their homes and into the West Bank.
Ahmed Atoun, one of the three affected, was attending a parliament session in the West Bank city of Ram Allah when the decision was made. He said it would not prevent him from going home.
"If they want to detain me, let them. They can't take me away from my house," he said, criticising the decision as a violation of international law and Israel's obligations to the Palestinian Authority.
"This is an unfair, criminal decision that I won't abide by."
Atoun said he would use all legal means to appeal against the decision. The Israeli Supreme Court has overturned government measures against Palestinians in the past.