The app will help users to find friends who are nearby, alert them when it detects one in close proximity even when the app is not open on the handset, it is claimed.
It will be just one of a whole suite of mobile apps Facebook is building up to help it profit from the increasing proportion of its users who access the social network on the go.
But privacy campaigners warned it was another example of 'profit trumping privacy' and called the function 'intrusive'.
Facebook's privacy policies already warn users that the social network may use location data to 'tell you and your friends about people or events nearby, or offer deals to you that you might be interested in.'The new app would help Facebook target advertising to users based on their location and their daily habits, helping corporate clients to reach the audiences they feel are most likely to want their products.
Plans for the app were leaked to Bloomberg by two people 'with knowledge of the matter', the financial news service said.
Development of Facebook's location software is being led by Peter Deng, a product director who joined the company from Google in 2007, one source said.
The team also includes engineers from Glancee, a location-tracking company Facebook bought out last May, and Gowalla, a location-based social network snapped up in December 2011, Bloomberg reported.
Facebook's privacy policies already warn users that the social network may use location data to 'tell you and your friends about people or events nearby, or offer deals to you that you might be interested in.'
Mr Zuckerberg last week boasted that the company had redirected itself to focus on becoming a truly mobile company, in a move that he feels is paying off since their mobile ad revenue is growing.
‘2012 was a big year for us,’ the 28-year-old social media entrepreneur said in a conference call following the release of the Q4 earnings report a day earlier.
Facebook's biggest challenge - and its greatest opportunity - lies in mobile devices which is an area that the company did not pay much attention to until just last year.
Most Facebook users access it using a mobile phone or tablet computer, yet the nine-year-old company only started showing mobile ads about nine months ago.
The company said it generated 23 per cent, or $306million, of advertising revenue from mobile, marking an increase from 14 per cent in the third quarter.
'When we get your GPS location, we put it together with other location information we have about you (like your current city),' says the social network's data use policy.
'But we only keep it until it is no longer useful to provide you services, like keeping your last GPS coordinates to send you relevant notifications.'