The High Court ruled federal laws passed to reclaim land the former Soviet nation had leased to build a new embassy in Canberra on national security grounds were valid.
But the Commonwealth was liable to pay a reasonable amount of compensation for acquiring the land under the constitution, it said in its judgment on Wednesday.
The Commonwealth will need to pay half of Russia's cost for the case.
The court rejected Russia's argument the laws weren't supported by the constitution.
Federal parliament can make laws about acquiring property but needs to do so "on just terms" as outlined in the constitution, the High Court's reasons stated, rejecting Russia's argument it was unconstitutional.
The Australian government had argued that this constitutional requirement shouldn't apply to the cancellation of a lease as it didn't fall within the definition of acquiring property, which was rejected by the court.
Another of its arguments was also rejected - that compensating Russia would be "incongruous" with the laws that were passed due to national security concerns over the use of the site for an embassy.
"The force of the argument is diminished when it is borne in mind that the lease was granted by the Commonwealth and paid for by the Russian Federation in accordance with Australian domestic law," the court stated.
Attorney-General Michelle Rowland welcomed the decision about the Commonwealth acting lawfully to terminate the lease.
"Australia will always stand up for our values and we will stand up for our national security," she said.
"The government will closely consider the next steps in light of the court's decision."
The Commonwealth can legally pay compensation for the acquisition of property despite sanctions.
In 2023, Australia quickly passed laws to cancel Russia's lease on a plot of land where it planned to build an embassy a few hundred metres from Parliament House.
Russia rejected the cancellation of the 99-year lease, which was granted by the Australian government in 2008, as hostile action amounting to "Russophobic hysteria".
No developments were completed on the plot, but an official squatted on the land after the decision to frustrate any Australian effort to reclaim it.
Top silk Bret Walker SC, representing Russia, previously argued it was offensive to assume people would willingly give up their property without compensation because national security grounds were invoked.
He cited an army barracks as an example, saying the Commonwealth would be within its rights to acquire land around the structure to protect security but would still be expected to pay the owners.
Solicitor-General Stephen Donaghue argued the government had the power and authority to make laws stripping the Russians of their lease.
The Commonwealth also relied on "specific advice" about the nature of the construction that was planned and the capacity the site's location would provide the Russian mission.
The advice from the Australian Security Intelligence Organisation was not detailed in court due to public interest immunity protections.
Compensation should not be paid to a nation for problems they cause themselves, Mr Donaghue told the High Court previously.
Mr Walker said it was really disturbing to propose the taking of land without compensation on pre-emptive national security grounds where no explicit threat had been proven.
He said such a precedent was absurd and would mean everyone is to be regarded, until proven otherwise, a terrorist threat.
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