The United States is preparing to hand control of Saddam Hussein's Republican Palace in Baghdad to the Iraqi Government in one of the most symbolic examples of the country's increasing sovereignty.

Plans are also under way to turn over swaths of the green zone, which surrounds the palace, to the Iraqi authorities, with Iraqi forces expected to replace US troops at some checkpoints over the next year, according to sources inside the compound.

The transition is part of a process in which the Iraqi Government has taken full responsibility for security in 11 out of 18 provinces as its police and army become increasingly competent.

The move also underscores a shift in the relationship between Iraq and the US, which is moving from being an occupying power to having a regular diplomatic presence. The new US Embassy building will be the biggest of its kind in the world.

The Republican Palace, a dust-coloured building with marble corridors and a blue dome on its roof, used to be the seat of Saddam's power. After the 2003 invasion it became the headquarters of the US-led coalition authority that ruled Iraq, remaining under US control even after power was handed to the transitional Government in June 2004.

Thousands of American, British, Australian and other foreign diplomats, military personnel and contractors work in the palace. Makeshift wooden walls divide up a network of large halls to create office space, a gymnasium and even a Starbucks-style coffee counter.

Many people lived at the palace, crammed into trailers around the grounds. Over the past few months they have been moving to a new embassy compound on the banks of the River Tigris inside the green zone.

“The move should be completed by the end of the year,” Susan Ziadeh, the US embassy spokeswoman, said. “Plans are under way to transfer the property back to the Iraqi Government,” she added without specifying a timeframe.

An Iraqi source said that it should happen in 2009. It is likely that the palace will used by the office of Nouri al-Maliki, the Iraqi Prime Minister.

The new embassy is vast and has been likened to a prison because of its characterless stone walls. However, its facilities include a tennis court, indoor swimming pool and gym.

"Compared to the trailers we have had these past five years, this is definitely an upgrade," one resident, who had just moved to a shared apartment inside the recently completed structure, said.

He added that it would be a shame to no longer work in the historic surroundings of Saddam's palace, but said: "I think it will be better for the mission because we are becoming more like a standard embassy.”

A large US-led military presence is also based at the palace. It also must be relocated before the Iraqi authorities can move in. The US military declined to specify when this was due to happen.

Rear-Admiral Patrick Driscoll, a military spokesman, said that a reduction of the coalition presence and an increased Iraqi presence for security was one of three objectives for the green zone. The others comprised development and investment.

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