Six clubs in the Israeli football league play in West Bank Jewish settlements, which are considered illegal under international law, the report said.
"By holding games on stolen land, FIFA is tarnishing the beautiful game of football," Sari Bashi, Israel and Palestine country director at the New York-based Human Rights Watch, said in a statement.
"Some of these games are played on land owned by individual Palestinians not allowed to access the area, while others are held on land belonging to Palestinian villages that the Israeli military seized and designated for exclusive Israeli civilian use," HRW’s Israel and Palestine country director Sari Bashi, told the French Press Agency.
To comply with international law, she said, the clubs "need to move their games inside Israel".
Israel seized the West Bank in the 1967 Middle East war.
The Palestinians have long opposed the participation in the Israeli championships of the settlement clubs, which play in Israel's third, fourth and fifth divisions.
FIFA is expected to discuss the issue at an October 13-14 meeting of its executive committee.
"FIFA will continue its efforts to promote friendly relations between our member associations in accordance with FIFA statutes and identify feasible solutions for the benefit of the game and everyone involved," it said in a statement to AFP.
Within Israel, reactions were angry. “It is disturbing, but not surprising, to see that Human Rights Watch [ ... ] the Palestinian Authority’s political warfare against Israel, this time in the campaign targeting Israel within FIFA. HRW has long supported BDS [Boycott, Divestment and Sanctions] campaigns against Israel, says NGO Monitor in a statement.
And the reaction of the Israel Football Association was that sport was being "dragged from the football field into a political one" but it had faith FIFA would deal correctly with the issue.
Palestinian Football Association (PFA) head Jibril Rajoub said they had asked the Asian Football Confederation and European Union to take up the case and were hopeful FIFA's executive committee would support them.
In theory, if the issue is not resolved, the PFA could renew its efforts to expel or suspend Israel from FIFA.