Police and members of a neighbourhood security unit raided a house thought to be used by Sunni Islamist al Qaeda in an area near Samarra, 100 km north of Baghdad, when they found 10 people who had been kidnapped from a nearby town.
Police said information from some of the people freed from that house led to the discovery of the grave nearby.
Local families had identified some of those buried in the grave but little other information was available, police said. Three car bombs were also found in the area.
The discovery of the mass grave came after Iraq's temporary new national flag was raised over the country's parliament for the first time in a ceremony trumpeted by the government as a break with the bloody past and a step towards reconciliation.
In another symbolic move, the government said it had started to rebuild a revered Shi'ite shrine in Samarra which was bombed two years ago, sparking sectarian violence which killed tens of thousands and took Iraq to the brink of civil war.
Prime Minister Nuri al-Maliki presided over the flag-raising outside his offices in Baghdad's heavily fortified Green Zone after parliament last month agreed to adopt the new flag.
Iraq's Kurdish minority has long demanded a new flag, saying the old banner was a reminder of Saddam Hussein's brutality.
"It erases the impact of the past," Maliki said. The flag will fly for a year before a permanent replacement is chosen.
Kurdish officials had refused to fly the old flag, introduced after the coup by Saddam's Baath party in 1963, and it was banned in largely autonomous northern Kurdistan.
Officials in Falluja in western Anbar province, once a Sunni Arab insurgent stronghold, have also said they would not fly it.
But many ordinary Iraqis saw the old flag as having little to do with Saddam, a Sunni Arab, and would prefer the government focused on issues such as improving basic services like electricity and water, which still run only intermittently.
"Our so-called leaders have been doing nothing for us so far and now they want to erase our symbolic flag and make a new one," said one woman in southern Baghdad's Doura neighbourhood.
HEAL WOUNDS
In another move to heal wounds, Maliki said Samarra and its al-Askari mosque which was badly damaged in a bombing by suspected al Qaeda militants in February 2006 would be rebuilt.
That bombing toppled the mosque's famed golden dome and unleashed savage sectarian fighting between majority Shi'ites and minority Sunni Muslims.
Samarra is in Salahuddin, one of Iraq's northern provinces where al Qaeda fighters have regrouped after being forced out of former strongholds in Anbar and around Baghdad during security crackdowns last year.
Attacks across Iraq have fallen 60 percent since last June, with the growth of the mainly Sunni Arab neighbourhood police units and 30,000 extra U.S. troops credited for sharply falling violence.
But U.S. and Iraqi commanders warn that al Qaeda remains a dangerous enemy and have launched a series of offensives in northern provinces this year.
The U.S. military said a civilian woman had been killed on Tuesday during a raid by its troops against al Qaeda suspects, the day after it admitted accidentally killing nine civilians.
The woman was killed when soldiers returned fire after being shot at as they entered a house in a town near Tikrit, 175 km (110 miles) north of Baghdad. Two men, suspected militants, were also killed and a young girl received leg wounds.
The killing of Iraqi civilians by U.S. soldiers has long put a strain on relations between Baghdad and Washington. The U.S. military says militants often deliberately use civilians as shields against attacking U.S. forces.
But critics say U.S. forces often fire on militants without taking reasonable care to find out who else is in the area.
Six suspected al Qaeda fighters were killed in other raids near Khalis, another town north of Baghdad, the military said.
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