"Goat Island has enormous cultural heritage significance for Aboriginal people," said NSW Premier Mike Baird. "We are committed to ensuring Aboriginal leadership in management and decision-making for the sustainable use of Goat Island.

"This is an incredible opportunity to recognise this unique site always was, and always will be, Aboriginal land."

Fairfax can reveal that the Baird government has taken its first steps to transfer management and ownership of the land to its traditional owners.

The Premier will establish a working group with the city's Aboriginal Land Council to investigate means of transferring management and ownership while continuing existing operations on the island while maintaining public access.

The state government's decision comes after Labor pushed for the island to be returned at last year's election.

"I'm very pleased that premier Mike Baird has done it," said former prime minister Paul Keating, who has long campaigned for the island's return.

Known firstly as Me-Mel, or the eye, the island is the centre of a constellation of green harbour headlands and, as an easy 500-metre paddle from the mainland, was used often by Indigenous people.

The island was the birthplace for the father of Bennelong, the Eora elder who served as intermediary between English settlers and Aboriginal populations.

Sydney's judge-advocate David Collins noted the example of the island with some surprise as a demonstration of an Aboriginal system of real estate.

In a 1798 account of Sydney's early history he quotes "Ben-nil-long" as describing the island as his inheritance and a place where he and his wife "Ba-rang-a-roo" often feasted and relaxed.

"To this little spot he appeared much attached," Collins wrote.

The last question asked by Indigenous MP Linda Burney before she left for federal politics was about returning ownership of the island.

Ms Burney has called for an expedient transfer of the title over the land under NSW land rights after the state Labor opposition promised the "cast-iron guarantee" of returning the land.

"It's such an important part of the Aboriginal story," Ms Burney said.

"We will work with Metro Local Aboriginal Land Council and other Aboriginal community representatives," said NSW Minister for Aboriginal Affairs Leslie Williams. "Future opportunities [include] increasing public access and sharing cultural experiences".

Mr Keating proposes returning the island as much as possible to its pre-colonial state.

"The land should be stripped of the industrial detritus, while keeping the important colonial buildings, as it should be stripped of the exotic species of flora which have inhabited it since European settlement," he said.

From 1833, the island was used to store Sydney's dynamite supplies, a building that became known as the Queen's Magazine.

The working group will develop a business case to "unlock the economic potential" of the island, the state government said.

Goat Island has been owned by the NSW government since 1908. It was first used by Europeans as a sandstone quarry.