The siege was ongoing late today, with gunshots ringing out as dozens of Afghan police deployed at the residence near the main parliament building battled an attacker holed up with grenades inside the house.
Jan Mohammad Khan, the former governor of southern Uruzgan province and a key ally of the embattled president, was killed in the attack along with an MP for Uruzgan, Mohammad Hashem Watanwal, said a police spokesman.
The attack comes less than a week after the president's half-brother Ahmed Wali Karzai was assassinated by a close friend at his home in the southern province of Kandahar, birthplace of the Taliban.
Sunday also marked the beginning of the national process of handing responsibility for security from foreign forces to Afghans, and the last day in the job for the top US commander in Afghanistan General David Petraeus.
Kabul police spokesman Hashmat Stanikzai said at least one of the gunmen in Sunday's raid was also dead and it was not clear whether the rest of Khan''s family had escaped or were still stuck inside the besieged residence.
"JMK (Jan Mohammad Khan) and Watanwal have been martyred and also one of the attackers has been killed," he told AFP, adding that the attack began at 8:00 pm (0900 IST) and that at least one attacker was still inside the house.
A security officer deployed near the house told AFP that a gunman had hidden in a bathroom in the house with grenades and was firing his automatic weapon. An AFP reporter at the scene could hear bursts of gunfire from the residence.
"They were not suicide bombers, they were carrying weapons. One of them is dead, one other is still resisting. He's on the third floor," said interior ministry spokesman Siddiq Siddiqi, adding that no foreign forces were taking part in the operation.
A senior intelligence official speaking anonymously said it was believed that three people attacked Khan's residence.
"Our security forces entered the house, some parts are clear but other parts are not, it's a big house. We captured one guy with an AK47 and grenade launcher," he said.
A government official speaking on condition of anonymity said: "He (Khan) was very close to Karzai. He was as important as AWK (Ahmed Wali Karzai)." Like Karzai, Khan hailed from a powerful family from the Popalzai tribe in Afghanistan''s restive south and was his key adviser for tribal issues.
According to the independent website afghan-bios.info, Khan's nephew runs a 3,000-strong militia in Uruzgan.
Khan escaped a previous assassination attempt on August 4 when a motorcycle bomb exploded by his convoy in the southern province. His death could further inflame the volatile politics of the southern region, where the Taliban are battling US-led troops for control of the area.