Heavy clashes in the Rafah refugee camp in southern Gaza have left two Israeli soldiers and a Palestinian dead.
The UN has condemned the demolition of houses
The army said the soldiers died from sniper fire as they were helping a Palestinian woman, rejecting militant claims of an attack on their vehicle.
The Palestinian man was killed in a missile strike on the refugee camp.
The fighting followed the razing of at least 10 homes by army bulldozers in the camp, as details emerged of Israeli plans to demolish hundreds more.
The UN criticised the demolitions, describing them as a catastrophe.
The al-Aqsa Martyrs' Brigade said it carried out an attack on an Israeli military vehicle that killed two Israeli soldiers and also injured two others.
The Israeli army's account was different.
"One soldier left a house in Rafah to come to the help of an elderly Palestinian woman who was carrying heavy bags of food and was felled by bullets fired by Palestinian snipers," a spokeswoman said.
"Shortly afterwards, our forces came to the assistance of the soldier and another soldier was killed by bullets while two more were wounded."
TOLL FROM LATEST VIOLENCE
14 May - Two Israeli soldiers and one Palestinian killed in the Rafah refugee camp
13 May - 12 Palestinians reported dead in Israeli raids on Rafah refugee camp
12 May - Five Israeli soldiers killed by a rocket fired by Palestinian gunmen near Rafah
11-12 May - 14 Palestinians killed during Israeli incursion in Gaza City
11 May - Six Israeli soldiers killed by an anti-tank bomb in Gaza City
The incident brings to 13 the number of Israelis who have died in the Gaza Strip this week.
They include six soldiers whose body parts were kept by Palestinian militants before being returned following Egyptian intervention.
Referring to this incident, Israeli Defence Minister Shaul Mofaz accused Palestinian militants of using United Nations ambulances to transport the remains of Israeli soldiers killed in clashes in the Gaza Strip.
Mr Mofaz described this as a violation and said the UN should comment on it.
There has been no reaction from the UN. Palestinians have denied the allegations.
A 27-year-old Palestinian, Akram Abu al-Naji, died on Friday when an Israeli helicopter fired two missiles into Rafah refugee camp.
Reports speak of panic-stricken residents holding onto personal belongings and waving white flags at approaching Israeli forces.
An official from Prime Minister Ariel Sharon's office called the demolition of houses in the camp a "legitimate defensive measure".
"[It] aimed at ensuring better protection for our soldiers who shouldn't remain as sitting ducks and at preventing the smuggling of weapons, mortars, rockets and tunnels between Egypt and the Gaza Strip," the official told AFP.
Israel controls a 9km (five mile) strip of land between the refugee camps of southern Gaza and the Egyptian border.
It is often the scene of fierce confrontation between Palestinian gunmen and the Israeli army.
The Palestinian Authority called on the international community to prevent the demolitions.
Paul McCann, a spokesman for the UN agency in charge of Palestinian refugees, condemned the policy and warned of a deepening crisis.
"It's impossible to believe that every one of these houses shelters militants or the entrance to a tunnel," Mr McCann said.
Mr McCann said he doubted Israeli Radio reports that Israel would assist the Palestinians in finding new homes for those made homeless.
"Israel has so far been taking the view that it is not responsible for humanitarian issues inside the Palestinian territories," Mr McCann said.
The BBC Jerusalem correspondent says Israel has suffered its worst military losses for two years, and the issue of withdrawing from Gaza has become the central political question.
A poll in the Israeli daily Yediot Ahronot suggested a sharp rise in support for Mr Sharon's plan for a unilateral withdrawal from Gaza.
Some 71% of respondents said they now approved of a pullout, compared with 62% on 4 May.