The house built by Kelly's father, John Kelly, will be revived using traditional trade skills after a heritage audit found the home needed protection.

The Andrews government will spend $1 million on the house in Beveridge in Melbourne's outer north.

The state government has also begun negotiations to buy the site from the landowners.

A heritage audit found the house, built in 1860 when Ned Kelly was five, was slumping with rotten verandah posts and guttering and downpipes that had become dilapidated.

Planning Minister Richard Wynne said John and Ellen Kelly lived in the two-bedroom house with their six children.

He said the government had held "productive" discussions with the landowners.

"They're keen to enter into an arrangement with us," he said.

Mr Wynne said the building was handmade but had fallen into a fragile state.

Once the house has been restored to a satisfactory condition it will be open to the public. It will then become part of a local heritage trail.

Heritage Victoria will oversee the restoration to preserve the cottage's historical integrity.

The house was deemed significant because of its similarity to a traditional Irish cottage. But other details also make it unique, including bush poles, shingles, guttering and a lack of eaves, the government said in a statement.

Three years ago Ned Kelly's descendants gathered in Glenrowan for the outlaw's belated funeral – 133 years after he died.

He was buried in the cemetery at Greta near the unmarked grave of his mother Ellen. Kelly's brother Dan was also buried in the same cemetery.