According to a police officer, the heavily armed militants entered the Jammu and Kashmir Entrepreneurship Development Institute (JKEDI) in Pampore town in the morning and began firing at security forces.
The militants changed their positions constantly to avoid getting killed, the officer said. "They are firing intermittently and frequently changing their position inside the building."
The security forces fired rockets and used light machine guns in a bid to localize the guerrillas so as to launch a final assault without suffering major casualties, official sources said.
The multi-storey government complex is located on the banks of the Jhelum river, some 12 km from the Srinagar city centre.
The joint operation was launched by the army, the Special Operations Group of the state police and the Central Reserve Police Force (CRPF) soon after the militants' presence was reported.
The fighting was raging for over six hours, officials said.
A soldier was injured when he sustained a gunshot on his foot.
"Security forces have surrounded the building and all escape routes have been sealed," a police officer said. The building has more than 200 rooms.
Residents in the area told IANS that the militants entered the institute from the river side and were holed up inside the hostel.
There were some JKEDI employees in the complex at the time of the attack but most said they were not sure how the militants got in.
"We don't know exactly what happened. We saw smoke coming out of the top floor of the hostel and called the fire brigade and police," one JKEDI employee said.
"When the security forces arrived, the militants began firing at them and suddenly guns were roaring from all sides," he added.
The main building of the institute was razed in February when militants captured it and launched a major attack on security forces.
Six persons - a civilian, three soldiers and two paramilitary troopers -- were killed then before three militants were gunned down.
The institute, situated on the strategic arterial road connecting Jammu and Srinagar, has three buildings - a guest house, a hostel complex and the main office building - on a 3.5-acre land on the Jhelum.
The road on which the institute is located is the lifeline not only for local supplies but is the only all-weather link used by the army to reach the Srinagar-based 15 Corps headquarters.
The area around the building houses a government-owned factory and a highly secured complex of medium and shortwave radio transmitters of Radio Kashmir, Srinagar.