JERUSALEM, March 26 (Douglas Hamilton - Reuters) - It's a toxic piece of real estate with a chequered history, in a flashpoint district of a turbulent city -- hardly a realtor's dream.

The derelict Shepherd Hotel in Jerusalem was built in the 1930s for Muslim grand mufti Haj Amin Husseini, who fought the British and Zionists and became a World War Two ally of Hitler.

Arabs, rise as one man and fight for your sacred rights. Kill the Jews wherever you find them, he is quoted as saying in one Nazi radio broadcast. This pleases God, history, and religion. This saves your honour. God is with you.

The mufti fled to Lebanon in 1937 and after Israel was created in 1948 his house was used as a British Army outpost. It was confiscated when Israel captured East Jerusalem from Jordan in 1967 and apparently used by Israeli justice authorities.

Plain-fronted, flat-roofed and unattractive, it was sold -- illegally say Palestinians -- to an Israeli company, and rented to a family who opened an hotel, but went bankrupt in the 1980s.
The complex was bought up by an American-Jewish entrepreneur in 1985 and rented out for 15 years to Israeli border police.

This week it became the latest thorn in the flesh of inflamed relations between Israel and the United States, because Israel has approved plans to develop a block of apartments on the site for Jews, whom the Palestinians say will swell the ranks of settlers in occupied Jerusalem land.

The hotel lies in Jerusalem's predominantly Arab Sheikh Jarrah district, where Palestinian families have been evicted and their houses ceded to Jews, creating tension in a neighbourhood that now sees frequent anti-settler protests and police patrols.

ROOM FOR 500
Noting plans for 100 homes, a synagogue, a kindergarten and a children's park, Palestinian negotiator Saeb Erekat said it would be a new settlement (for) up to 500 new settlers, and further step in Israel's attempt to forcibly end any Palestinian presence in East Jerusalem.

Washington, already at loggerheads with Israel over its plans for continuing expansion in disputed Jerusalem suburbs, said it was seeking clarification of the scheme.

Israel denies any plot to Judaise the city it claims as its eternal and indivisible capital, as witnessed by the Bible and history. It accepts no limits on where Jews may build, although Mayor Nir Barkat was persuaded by the government this month to freeze demolition of illegal Palestinian homes.

Israel's claim is not recognized internationally. Big powers see East Jerusalem as future capital of a Palestinian state, if the Palestinians and Israel make peace. Its settlements in the West Bank and East Jerusalem are also considered illegitimate.

But Israel does not accept these judgements.
Israeli construction policy in Jerusalem has remained the same for 42 years and isn't changing, said a statement from Prime Minister Benjamin Netanyahu's office on Friday.

Interior Minister Eli Yishai told the ultra-Orthodox newspaper Yom Leyom this week: I thank the Lord that I have been given the privilege to be the minister who approves the construction of thousands of housing units in Jerusalem.

The hotel sits among pines in a scruffy 1.5 acres of sunny hillside near Western consulates, including the British. Adnan al-Husseini, the Palestinian governor of Jerusalem who has no actual power of the city, said the grand mufti never lived in the place but rented it out to Palestinian families, one of whom had it enlarged.

The building was declared absentee property by Israel after it occupied East Jerusalem. Title was transferred to an Israeli company, which sold it in 1985 to Irving Moskowitz, a Florida bingo king and patron of Jewish settlers. Israel is not being asked to make any concessions, says Erekat. Rolling back the occupation, ending illegal settlement construction, and adhering to international law and existing agreements are not concessions.