Australian PM John Howard says some troops in Iraq will take on what he called a "higher risk" role.
The Australian troops will help train Iraqi forces
About 460 Australian troops will move from Samawa in the south to Tallil, Mr Howard said.
They will help to train Iraqi forces, and could, "in extreme cases", support Iraq troops in direct military action.
The moves comes as the Australian military said it regretted an incident in Baghdad in which troops killed one of the Iraqi trade minister's guards.
Mr Howard told parliament that the soldiers would relocate to an airbase in Tallil, approximately 80km (50 miles) southeast of their current base in Samawa, Muthana province, where they will take part in reconstruction work and training Iraqi troops.
The soldiers have been guarding a Japanese contingent in Samawa, but Tokyo announced on 20 June that it is to withdraw its troops.
British and Australian troops are preparing to hand over security in Muthana province to Iraqi forces.
Mr Howard said the troops could also provide support in areas such as surveillance and intelligence.
"Should situations develop that are beyond the capacity of the Iraqi security forces to resolve, the Iraqi government may call upon the coalition to provide them with back-up," Mr Howard said.
While Australian troops would be operating in areas with a low threat level, the troops' "new role will be higher risk", he said.
The announcement comes as an incident in Baghdad threatened to derail ties between the Australian military and the Iraqi leadership.
On Wednesday, a security team guarding Australian diplomats reportedly mistook Trade Minister Abdul Falah al-Sudani's plainclothes guards for insurgents. One guard was shot dead and several others were wounded in the incident.
"The ADF deeply regrets the injuries and loss of life that has occurred," Lt-Gen Ken Gillespie, Vice-Chief of the Australian Defence Force said in a statement. "As with all ADF incidents of this nature the matter will be formally and fully investigated."
A spokesman told Reuters news agency the minister was seeking an apology and compensation.
"If this does not happen he will reconsider trade agreements between the two countries," the spokesman said.
About 1,400 Australian defence force personnel are serving in or near Iraq.