JERUSALEM (Reuters) - When Palestinian Sharif Attoun asked bulldozer driver Ziad Dabash to flatten his home in Arab East Jerusalem, his friend was heartbroken.

But for Attoun, watching his 13-year-old house being demolished by a friend was a lesser evil: If Dabash wouldn't do it, Israeli authorities would have, a move that comes with some $20,000 in demolition fees and possible imprisonment.

Attoun's ordeal is not uncommon among some 260,000 Palestinians living in Arab East Jerusalem who say Israeli municipal authorities in the city often deny them building permits.

I never thought of razing my own home and paying rent, said Attoun, a 36-year-old elevator technician, waving a copy of the Israeli demolition order.

Israel captured and later annexed East Jerusalem in the 1967 Middle East war in a move not recognized internationally.

The Jewish state considers the whole city as its eternal capital and says it is implementing the law by demolishing houses built without permission.

Palestinian President Mahmoud Abbas wants East Jerusalem to be the capital of a future independent state and has sharply criticized the demolitions and the expansion of Jewish settlements in East Jerusalem and across the occupied West Bank.

Palestinians accuse Israel of mounting a concerted campaign to deny them statehood and to push them out of the Holy City.

During a visit to Jerusalem and the West Bank this week, U.S. Secretary of State Hillary Clinton criticized as unhelpful Israeli plans to demolish some 80 homes in East Jerusalem to make way for a municipal park.

CRUEL

Palestinians in Jerusalem carry Israeli identity cards, giving them access to welfare and health services, and freedom of movement denied to Palestinians in the occupied West Bank. But few East Jerusalemites have taken up full Israeli citizenship.

It's the most cruel thing I did in my lifetime, but it was the lesser of two evils, said Attoun, a father of six, standing in front of a pile of rubble and twisted steel rods that used to be his house.

Attoun will pay bulldozer driver Dabash for his work but only a fraction of what Israel would charge him.

It was the third time in 16 years that Dabash has knocked down a fellow Palestinian's home.

For many Palestinians, bulldozers are a symbol of the Israeli occupation. They are used by the army to flatten homes in the West Bank, East Jerusalem and the Gaza Strip. Israel says it targets militants and lawbreakers.

For many Israelis, bulldozers are increasingly associated with Palestinian attacks. Wednesday, a Palestinian man used his bulldozer to crush a police car in Jerusalem, the third such incident in a year.

Ziyad Hammouri, head of the Jerusalem Center for Social and Economic Rights, said Israel has demolished some 30 homes in Arab East Jerusalem so far this year.

He said Attoun's decision to flatten his own home was rare.

Hatem Abdel Qader, Palestinian Prime Minister Salam Fayyad's representative in the city, said Attoun's actions were counterproductive because it allowed Israel to deflect responsibility for crimes they are committing in Jerusalem.

He said Fayyad should mount a campaign to help Palestinian homeowners in East Jerusalem to counter what he termed Israelisation of the area by demolishing buildings and seizing land.

Sarit Michaeli, of Israeli Human Rights group B'Tselem, said the Jewish state's policies in the city since 1967 left Palestinians little choice but to build illegally.

The issue of Jerusalem is sensitive for both sides, and Israeli prime minister-designate, rightist Benjamin Netanyahu, has all-but ruled out even discussing dividing the city, where some 500,000 Jews live.

(Editing by Joseph Nasr and Samia Nakhoul)

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