The recently elected Labor government of Prime Minister Julia Gillard also said vulnerable asylum-seekers, especially those with children, would be moved out of detention centers and into the community.
Gillard expects "significant numbers" of minors and their families would be relocated into community-based accommodations as part of a more "humane" approach to housing the refugees.
Families living in a community will have to live according to strict rules, such as tight curfews and frequent checks by immigration officials. Also, children living in the community will have to attend a local school, she said.
"This is especially important for children, for whom protracted detention can have negative impacts on their development and mental health," Gillard said. "I don't think it is the Australian way to have kids behind razor wire in the hope that that is a deterrent."
But the move won't take place until the middle of next year.
The vast majority of the refugees -- around 5,000 so far this year -- have arrived in Australian waters after a desperate journey in unseaworthy boats from Indonesia and countries further west. Many are Tamils from Sri Lanka, as well as Afghanis and Iraqis.
Gillard's announcement comes as the country's detention centers are reaching, and in some cases surpassing, their limit to hold refugees, especially the main detention center located on Australia's overseas territory Christmas Island. Overcrowding at the center has meant many temporary shelters, including tents.
There also have been protests by refugees at centers in the cities of Sydney and Darwin.
To ease the pressures on existing centers, the government said it will build two more to hold around 1,900 refugees. One will be at Northam, near Perth on the west coast, and the other at Inverbrackie, in the Adelaide Hills area.
But the Refugee Action Coalition said opening more detention centers is "disgraceful," as is putting families into communities.
"Their proposal is community-based detention, it's about detention, not actually allowing people to live freely in the community," RAC representative Ian Rintoul said.
"Secondly, they're talking about it's going to take them until June 2011 even to deal with the present number of families and unaccompanied minors, so that's just a disgrace."
Amnesty International welcomed the plan to move families and children into the community but was disappointed the government remains committed to detaining refugees in the first place.
"The announcement that the government will establish two new detention facilities is disappointing and represents a missed opportunity for the government to move decisively away from the failed policy of mandatory detention," Amnesty International's refugee coordinator Graham Thom said.
"As Amnesty International has highlighted time and again, Australia is the only country to mandatorily detain asylum seekers in this way."
Gillard's announcement is latest in a long list of plans about what to do with the increasing numbers of refugees and isn't likely to be a solution in the long run. It also has highlighted a growing not-in-my-back-yard backlash by local politicians to having refugees dumped, as they see it, in their constituencies.
The Northam shire President Steve Pollard said he was informed of the government's decision to renovate an old disused army barracks in his area only an hour before Gillard made the announcement.
"The question is about the legality of things, how many people are there, what would happen to them if they're released, when they're released from detention," he said.
"Could the town of Northam accommodate them, should the town of Northam accommodate them, who will be here from the Immigration Department's point of view?"
He said there are questions over what will be built.
"We haven't gone through a process of seeing what exactly the federal government is going to do with the 1,500-bed facility, whether that's going to be in 20 buildings, 40 buildings, whether they're going to build barb wire, what exactly they have in mind," he said.
Western Australia Premier Colin Barnett said the Northam decision shows the federal government's border protection policies aren't working. "We acknowledge that the Commonwealth probably has little choice but it is true that their policy on asylum seekers is not working. I am concerned about the security and safety of the residents of Northam."
Gillard also is continuing discussions with the government of Timor-Leste, one half of Timor Island off Australia's north coast. She is pushing for an agreement for Australia to pay for a temporary detention center that could be run by international aid or refugee agencies.
The Timor-Leste solution is a remnant of former Liberal Party Prime Minister John Howard's so-called "Pacific Solution" of housing refugees in detention centers off the Australian mainland.
Liberal opposition immigration spokesman Scott Morrison said the refugee system is under stress because the Labor government's border protection policies have failed.
"More beds doesn't stop more boats," Morrison said.