"Moth Smoke" is being adapted from the debut novel of Pakistan-born writer Mohsin Hamid about a social misfit who begins an affair with his best friend's wife against the backdrop of nuclear tests by India and Pakistan in 1998.
"I have been eagerly waiting for something on which I could work with Asif again," Khan told the film industry bible Variety as the project was unveiled at the Cannes film festival.
He starred in Kapadia's debut hit "The Warrior".
British-born Kapadia is best known for his acclaimed documentaries "Senna", about the Formula One legend Ayrton Senna, and "Amy", an intimate portrayal of tragic singer Amy Winehouse, which won him an Oscar last year.
"Slumdog Millionaire" producer Dina Dattani said that given the political tension between India and Pakistan, it is not yet clear where or when the film would start shooting.
"It is too early to decide on location. We will consider both Pakistan and India for the shoot," she added.
Kapadia is currently working on a documentary about football legend Diego Maradona.