The Supreme Court ruling is the latest in the long series of demolition deadlines and postponements for the Amona wildcat settlement, which is home to some 50 families.
The state "must act to carry out the demolition orders to all the structures in the locale, as they had committed to," the ruling read, noting a grace period of two years to enable the families to resettle.
The decision noted that there were still ongoing cases regarding the ownership of plots in the Amona settlement in other courts.
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Amona is the largest outpost in the West Bank, and was built on lands near Ramallah privately owned by Palestinians, who were behind the court petition.
Israel considers settlement outposts built without government approval to be illegal and often sends security personnel to demolish them.
In June, Jerusalem Magistrate's Court ordered that the state pay six Palestinian landowners 300,000 shekels ($85,700) in compensation for their losses from the presence of settlers on their land in Amona.
The international community considers all settlements built in the West Bank -- including east Jerusalem -- to be illegal.
In 2006 the state dismantled nine houses that made up the outpost at the time, with some 250 people wounded in clashes that erupted between law enforcement officials, the settlers and their supporters.