The bungalow stands on Carter Road in suburban Bandra and the demolition work is underway for the past two weeks now.
After Khanna's death in 2012, his family sold off the bungalow for a reported sum of Rs 90 crore to Shashi Kiran Shetty, founder and chairman of AllCargo Logistics.
Shetty has decided to build a new four-storey residence where he would stay with his family, sources said.
Khanna, fondly called Kaka by his colleagues and fans, had bought the bungalow from another yesteryear Bollywood star, Rajendra Kumar, in the late 1960s.