Egypt, which denied making any such preparations, has repeatedly raised the alarm over the possibility that Israel's devastating Gaza offensive could displace Palestinians into Sinai - something Cairo says would be completely unacceptable- echoing warnings from Arab states such as Jordan.
The United States has repeatedly said it would oppose any displacement of Palestinians out of Gaza.
One of the sources said Egypt was optimistic talks to clinch a ceasefire can avoid any such scenario, but is establishing the area at the border as a temporary and precautionary measure.
Three security sources said Egypt had begun preparing a desert area with some basic facilities which could be used to shelter Palestinians, emphasising this was a contingency step.
The sources Reuters spoke to for this story declined to be named because of the sensitivity of the matter.
Israel has said it will mount an offensive to take out Hamas's "last bastion" in Rafah, where well over 1 million Palestinians have sought sanctuary from its devastating Gaza offensive.
Israel has said its army is drawing up a plan to evacuate civilians from Rafah to other parts of the Gaza Strip.
But U.N. aid chief Martin Griffiths said on Thursday it was an "illusion" to think people in Gaza could evacuate to a safe place and warned of the possibility of Palestinians spilling into Egypt if Israel launches a military operation in Rafah.
He called this scenario "a sort of Egyptian nightmare".
Egypt has framed its opposition to the displacement of Palestinians from Gaza as part of wider Arab rejection of any repeat of the "Nakba", or "catastrophe", when some 700,000 Palestinians fled or were forced from their homes in the war surrounding Israel's creation in 1948.
The first source said construction of the camp began three or four days ago and it would offer temporary shelter in any scenario of people crossing the frontier "until a resolution is reached".
Asked about the accounts by the sources, the head of Egypt's State Information Service said: "This has no basis in truth. Our Palestinian brothers have said and Egypt has said that there is no preparation for this possibility."
Sinai Foundation for Human Rights, an activist organisation, published images on Monday it said showed construction trucks and cranes working in the area and images of concrete barriers.
Citing an unidentified source, the Sinai Foundation said that the construction work was intended to create a secured area in case of a mass exodus of Palestinians.
Reuters was able to confirm the location of part of the video as Rafah from the position of the buildings, trees and fences which match satellite imagery of the area.
Reuters was not able to confirm the location of the whole of the video or the date on which it was filmed.
ISRAEL TIES UNDER PRESSURE
Some 1.5 million Palestinians are currently in Rafah, more than half of the Gaza Strip's population, according to the U.N. agency for Palestinian refugees.
Israel says it needs to expand its assault into Rafah to wipe out Hamas, the group behind the Oct. 7 attack in which 1,200 people were killed in Israel and another 250 abducted, according to Israeli tallies.
With more than 28,000 people already killed in Israel's offensive in Gaza, according to health authorities in Hamas-run Gaza, the fate of people sheltering in Rafah has become a point of international concern, including for Israel's Western allies.
U.S. President Joe Biden has told Israeli Prime Minister Benjamin Netanyahu that Israel should not proceed with a Rafah operation without a plan to ensure the safety of the people sheltering there.
A U.S. State Department spokesperson said: "The president has been clear that we do not support the forced displacement of Palestinians from Gaza. The U.S. is not funding camps in Egypt for displaced Palestinians."
Netanyahu's office has ordered the army to draw up a plan to evacuate Rafah. But no plan has emerged yet.
Netanyahu, in an interview with ABC News, said they could go to areas north of Rafah cleared by the army.
Avi Dichter, Israel's minister of agriculture and rural development, said on Wednesday the evacuation was "a military issue" and the Israeli army knew how to do it.
In comments to Israel's Army Radio, Dichter said there was "enough land west of Rafah", and mentioned Al Mawasi - an area on the shore to which the Israeli military said civilians should flee early in the offensive.
The Gaza war has piled pressure on relations between Egypt and Israel, which signed a peace deal in 1979.
Arab League Secretary General Ahmed Aboul Gheit, a former Egyptian foreign minister, said earlier this week Israeli actions threatened the continuity of agreements with Egypt and Jordan - a reference to peace treaties with both Arab states.
Egyptian Foreign Minister Sameh Shoukry said on Feb. 12 Egypt had maintained the agreement for 40 years and would continue to do so as long as both sides were committed to it.
(Reporting by Reuters journalists; Editing by Tom Perry, Edmund Blair and Neil Fullick)
