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The conservative Austria's People's Party and the far-right Freedom Party forged the alliance, Austrian public broadcaster ORF reported on Friday.
The People Party's Sebastian Kurz will be the new chancellor. The Freedom Party's Heinz-Christian Stache will be his deputy. Kurz, 31, will be Europe's youngest leader.
This development comes after elections in October.
It would make Austria the only country in Western Europe to have a far-right party in government. It is the first time the far right is in an Austrian government coalition in more than 10 years.
Austria was governed by a coalition led by Chancellor Christian Kern's Social Democrats and Kurz's People's Party, but that partnership collapsed in May, prompting a snap vote.
The People's Party won the election but needed to form a coalition because it didn't win a majority of the votes.
The Freedom Party has a long history in Austria's Parliament and was part of a coalition government between 2000 and 2005.
There has been a rise across Europe of populist far-right parties, many of which have campaigned on anti-immigration platforms.
Immigration has dominated the campaign. Kurz has taken a hard line, calling for limits on the number of refugees entering Europe and benefits cuts for EU migrants living in Austria.
In 2016, Kurz spearheaded a border crackdown across the Balkans designed to stem the flow of migrants, and this year he proposed plans to seal off the Mediterranean route to Europe.