Ibrahim Hamid, who was on Israel's most-wanted list for eight years, was arrested in the West Bank city of Ram Allah, an army spokeswoman said.
He is a member of the Islamist group Hamas' military branch, the Izz al-Din al-Qassam Brigades.
The short incursion on Tuesday morning involved several Jeeps and a bulldozer in an area only 200m away from the house of Mahmoud Abbas, the Palestinian president.
Raid near Abbas' house
Witnesses said Israeli soldiers opened fire at a nearby building where Hamid was hiding and later raided it.
An Aljazeera cameraman at the scene, who was briefly held by soldiers and had his identification papers confiscated, said the building gates were subsequently blown up.
Hamas, which heads the Palestinian government since March after winning January elections, is formally committed to Israel's destruction, but has largely abided by a 15-month truce.
Israeli military action against Hamas has become less frequent, with security forces focusing their efforts on another group, Islamic Jihad, which has spurned ceasefire efforts and carried out most of the recent bomb attacks.
In Bethlehem, the Israeli army said it also arrested two Islamic Jihad members and five suspected figures from the mainstream, secular Fatah faction, which is headed by Abbas.