The Palestinian Islamic Jihad militant group said the man was Khaled Mansour – their top official for the southern Gaza Strip.
The strike in the southern city of Rafah also killed two fellow militants and five other civilians, including a child and three women, the group said.
Israel’s caretaker Prime Minister Yair Lapid confirmed that Israel Defence Forces (IDF) and the Israel Security Agency, better known as Shin Bet, had “thwarted” the leader.
“This is an operational and conscious effort, and an extraordinary achievement,” he said.
“We are acting in a focused and responsible manner in order to minimise harm to those not involved. The operation will continue as long as necessary.”
The strike came after Israel killed the Iranian-backed group’s northern Gaza commander in an air raid that triggered the worst cross-border conflict between Israel and Palestinian militants since last year.
Islamic Jihad said it would “not let their blood dry before they bombard the settlements of the enemy”.
Around 30 Palestinians killed in weekend of fighting
A total of 31 Palestinians, including six children and four women, have been killed so far in the fighting, according to the Palestinian Ministry of Health, while tens of thousands of Israelis have fled to shelters.
Militants from Islamic Jihad continued firing rockets toward Israel and the Israeli military continued airstrikes on Gaza, though the intensity of the exchange had decreased by the early hours of Sunday.
A close-up video showed the dramatic moment Israeli fighter jets dropped two bombs on the house of an Islamic Jihad member.
Sirens warning of rockets sounded in several communities just west of Jerusalem, with an Israeli military spokesperson saying rockets had been intercepted and no casualties or damage had been caused.
On Saturday, the Israeli military said an errant rocket fired by Palestinian militants killed civilians, including children, late in the town of Jabaliya, in northern Gaza.
It added that the incident was “without a doubt” caused by a misfire on the part of the Islamic Jihad.
A Palestinian medical worker said at least six people were killed in the blast.
Israeli airstrikes on the same day also killed a 75-year-old woman and wounded six others as they were preparing to go to a wedding.
Will Hamas get involved?
While fighting has been taking place since Friday, Hamas, the larger militant group in Gaza, has appeared to remain on the sidelines of the conflict.
The group has kept its response limited after battling Israel barely a year ago, in one of the four major conflicts to hit the region in the last 15 years.