The future status of Jerusalem will be on the agenda at next month's planned Middle East peace conference, according to Israel's vice premier Haim Ramon.
"Whoever thinks parties will only discuss the structure of Palestinian Authority institutions is deluded," Mr Ramon said, quoted by Israeli media.
Palestinians want the talks to tackle "final status" issues, including Jerusalem, though Israel is reluctant.
Israel occupied East Jerusalem, now home to 240,000 Palestinians, in 1967.
Since its victory in the 1967 Arab-Israeli war, it has settled hundreds of thousands of its citizens there and claims the entire city as its "eternal, indivisible" capital.
"Israel has an interest to get recognition of all of Jerusalem's Jewish neighbourhoods, and to hand over control of Arab neighbourhoods to the Palestinians," Mr Ramon said.
"When we speak of a diplomatic horizon, these are the subjects we are referring to," he added in comments reported by Jerusalem Post.
However, he said Israel would not transfer control of the Old City with its holy places and surrounding neighbourhoods to the Palestinians.
Ramon has previously backed "special sovereignty" over the city's holy sites, while the Western Wall and Jewish Quarter would come under Israeli sovereignty.
The Kadima party of Mr Ramon and Prime Minister Ehud Olmert won last year's elections with programme that favoured unilaterally demarcating Israel's borders with the Palestinians.
Kadima colleagues have criticised his position, arguing that the whole of Jerusalem must remain under Israeli control.