Palestinian officials told AFP that negotiators would meet at 8:00 pm in Jerusalem's King David hotel, although there was no Israeli confirmation.
As Palestinians celebrated the release of a first batch of 104 prisoners, most of whom had been serving life for killing Israelis, Housing Minister Uri Ariel vowed to build thousands more settler homes in the West Bank.
"We will build thousands of homes in the coming year in Judaea and Samaria," Ariel told public radio. "No one dictates where we can build... This is just the first course," he added, hinting at more building to come.
His provocative remarks were made as the negotiating teams readied for their first direct talks in nearly three years, following marathon efforts by US Secretary of State John Kerry who convened an initial meeting between the sides in Washington on July 30.
Although the overnight prisoner release was welcomed by the Palestinians, it did little to placate their anger after Israel announced plans to push on with 2,129 new settler homes -- the vast majority in annexed east Jerusalem.
An initial announcement on Sunday of 1,187 new homes was followed a day later by the approval of another 942 units in east Jerusalem, infuriating the Palestinians who want the
"This settlement expansion is unprecedented," senior Palestinian official Yasser Abed Rabbo told AFP. "It threatens to make talks fail even before they've started."
The last round of direct peace talks broke down just weeks after they were launched in September 2010 in a bitter row over settlements.
In a bid to defuse the latest crisis, Kerry phoned Palestinian president Mahmud Abbas late on Tuesday, a senior Palestinian official told AFP.
"We are waiting for the United States to take a clear stance on the escalating settlement building, which we consider the biggest obstacle that Israel is creating to stop serious talks from happening," the source said.
So far, both sides have remained tightlipped over the agenda for the negotiations.
Israel's chief negotiator Tzipi Livni will sit down with her Palestinian counterpart Saeb Erakat for talks presided over by US special envoy Martin Indyk.
But Israel's hawkish Defence Minister Moshe Yaalon was hard put to hide his scepticism.
"We set ourselves nine months in which to try and reach something with the Palestinians -- we've been trying for 20 years since Oslo," he said, referring to peace accords signed in September 1993.
"A note of scepticism might be detected in my words but we decided to give the negotiations a chance," he said.
Commentators said the timing of the settlement announcements was aimed at appeasing hardliners in the rightwing coalition of Prime Minister Benjamin Netanyahu but was also something of a quid pro quo for the prisoner release.
Ahead of the talks, Israel made good on a pledge to release 26 long-term prisoners, a key component of the deal which brought the Palestinians back to the negotiating table.
Eleven of them received a hero's welcome at the Muqataa presidential compound in the West Bank city of Ramallah where they were met by thousands of cheering, dancing supporters.
"This is the first group," Abbas told the crowd. "We shall continue until we free all the prisoners from Israeli jails," he promised.
At the same time, the remaining 15 prisoners crossed into Gaza where they were mobbed by a joyful crowd of about 2,000 people at the border as fireworks lit up the sky.
"I didn't see my son Atya for eight years, I thought I was going to die before I saw him again," said 65-year-old Atta Abu Mussa. "I am so happy!"
The 26 were the first batch of some 104 long-term detainees who are to be freed in stages contingent on progress in the negotiations.
Gaza's Hamas rulers did not comment on the prisoner release but lashed out at Abbas's rival administration for agreeing to enter talks with Israel.
"It is a national crime which will have serious consequences for our people and their rights and unity," said spokesman Fawzi Barhum.
Overnight, Israel bombed targets in northern Gaza after militants fired rockets across the border in the first such strike in seven weeks, the army said.