The decision was announced after a meeting of Prime Minister Benjamin Netanyahu’s security cabinet.
The Bedouin village, home to 180 Palestinians, is situated east of the occupied holy city of Jerusalem (al-Quds) between two Israeli settlements.
Israel claims Khan al-Ahmar was built without the required permits but Palestinians say such documents are impossible to obtain.
The European Union and the United Nations have urged Israel to abandon the plan to demolish Khan al-Ahmar and relocate its 180 residents to an area about 12 km (seven miles) away next to a landfill in the West Bank.
Foreign pressure was ramped up on Wednesday when the International Criminal Court prosecutor said in a statement about Khan al-Ahmar that population transfers in occupied territory constitute war crimes. Israel occupied the West Bank in a 1967 war.