Immigration Minister Alex Hawke has decided to allow the Murugappan family to live in community detention in Perth.
But he is yet to make a decision on whether any of the family members can reapply for visas to stay in Australia.
"Today's decision does not create a pathway to a visa," Mr Hawke said in a statement on Tuesday.
"As required by court orders, I will consider at a future date whether to lift the statutory bar presently preventing members of the family from reapplying for temporary protection, for which they have been previously rejected."
Mr Hawke claimed granting a permanent visa to the family would "absolutely" start a flood of people-smuggling boats.
There is also no obvious pathway for the family to return to Biloela in Queensland, where they were living before being taken into immigration detention.
The family has been locked up since 2018 while their fight against deportation has gone through the courts.
Their plight re-entered the spotlight last week after four-year-old Tharnicaa was flown to the mainland for medical treatment.
Tharnicaa's mother Priya is with her at Perth Children's Hospital but her father Nades and older sister Kopika, six, are still on Christmas Island.
A charter flight is on its way to collect them.
"In making this determination I am balancing the government's ongoing commitment to strong border protection policies with appropriate compassion involving children in held detention," Mr Hawke said.
"The family will now reside in suburban Perth through a community detention placement, close to schools and support services, while the youngest child receives medical treatment."
Labor deputy leader Richard Marles described the family's release as common sense.
"The last place this family should be is on Christmas Island at the enormous expense to the Australian public," he said.
"You have ministerial discretion so there can be the rule of common sense applying and that's what matters here."
Mr Marles said showing compassion and exercising discretion would not erode the country's border laws or restart the people-smuggling trade.
"None of that is being altered. That regime is still absolutely there."
Family friend Angela Fredericks said their release had been more than three years in the making.
She hopes community detention is only a temporary step.