The prime minister said he is open to moving Australia's embassy in Israel, but confirmed Australia remained committed to a two-state solution between Israel and Palestine.
The federal opposition has accused Scott Morrison of "desperation" after the prime minister confirmed he's considering moving Australia's embassy in Israel.
Mr Morrison could follow US President Donald Trump's lead and relocate the embassy to Jerusalem from Tel Aviv.
He has also announced an inquiry into support for the Iran nuclear deal and confirmed Australia would this week vote against the Palestinian Authority chairing a UN group.
"As a new prime minister, I believed it was important to ensure that Australians and others had a much clearer picture of my broader position on these issues raised in relation to the Middle East," he told reporters in Canberra on Tuesday.
The prime minister insisted Australia remained committed to a two-state solution between Israel and Palestine.
"Australia's position on this issue has, to date, assumed that it is not possible to consider the question of the recognition of Israel's capital in Jerusalem and that be consistent with pursuing a two-state solution," he said.
"You can achieve both and indeed by pursuing both you are actually aiding the cause for a two-state solution."
The significant foreign policy shifts come just five days out from a by-election in the Sydney Liberal seat of Wentworth, where 12.5 per cent of voters are Jewish.
Opposition foreign affairs spokeswoman Penny Wong said the prime minister was playing "dangerous and deceitful" word games.
"Foreign policy, and Australia's national interest are far too important to be played with in this fashion," Senator Wong said.
"The people of Wentworth, and all Australians, deserve a leader who puts the national interest ahead of his self-interest, and governs in the best long-term interest of the nation."
Israeli Prime Minister Benjamin Netanyahu has expressed his thanks to Mr Morrison.
"I spoke today with Australian PM ScottMorrisonMP," Mr Netanyahu tweeted.
"He informed me that he is considering officially recognizing Jerusalem as the capital of Israel & moving the Australian embassy to Jerusalem.
"I'm very thankful to him for this."
Mr Morrison has credited the Liberal Party's Wentworth by-election candidate Dave Sharma, a former Australian ambassador to Israel, with raising the issue.
If Australia does proceed, it will be following the US which earlier this year moved its embassy, effectively recognising the holy city of Jerusalem as the 'true' capital of Israel.
It would also be a major departure from the position taken by former prime minister Mr Turnbull and former foreign minister Julie Bishop.
During an interview on ABC radio, Mr Sharma pointed out he first made comments around moving the Israeli embassy in May and said the way the US moved its embassy was not consultative.
Mr Sharma said he would have preferred the US stick with the Iran deal but it made sense for Australia to review its position in light of the withdrawal.
Labor and the coalition - along with the United Kingdom, France, Germany - have until now backed the Iran nuclear weapons deal.
In March, Ms Bishop criticised the US pulling out and recommitted Australia to support the deal.