The Farrer by-election was triggered by the resignation of former Liberal leader Sussan Ley, ousted by Angus Taylor during a leadership spill in February.
The Liberal Party had held the seat for 25 years but voters were not convinced by candidate Raissa Butkowski.
Results coming in from across the sprawling electorate showed a primary swing against the Liberals of over 30 per cent.
The Coalition combined had about 20 per cent of the vote shortly before 8pm on Saturday.
One Nation's David Farley had just over 42 per cent of votes with 63 of 94 polling places returned.
It will be the conservative populist party's first win in the lower house, with Mr Farley joining Barnaby Joyce who defected from the Nationals to the party in December.
One Nation was always going to be a favourite in Farrer, Nationals Senate Leader Bridget McKenzie said.
"(The Nationals) haven't held this seat for quarter of a century, we have started from zero," she told the ABC.
"This is a conservative seat ... there's a lot of frustration with Canberra and there was a lot of frustration locally because they had a local member who resigned before her time."
One Nation Leader Pauline Hanson said the party would tackle water buybacks if they are successful in Farrer.
"(Voters) realised that we are the last hope of changing things in this country, to get it back to the country that we used to be," Senator Hanson told Sky News.
"People have fear for the future generations, no hope of owning their own home and the cost of living is just destroying families."
The most likely alternative to One Nation was independent Michelle Milthorpe but the 25 per cent of the vote she secured was not enough.
Labor didn't field a candidate.
Polling booths closed at 6pm and a show-and-tell ballot tip, marking the launch of counting, was staged.
While Mr Farley and Ms Milthorpe appeared close in lead-up polls, preferences from coalition voters would likely give the One Nation candidate an edge, RedBridge pollster Tony Barry told AAP.
"With the coalition preferencing One Nation, they are the intuitive choice to win the seat."
A One Nation victory would show the party was a strong electoral force, particularly in regional areas, the former Liberal strategist said.
"If they cannibalise the Liberal and National Party vote as expected, then it's a very safe conclusion to say that we're going to see similar voting behaviours and patterns in other regional seats."
Farrer has been held by either the Liberal or National party since its inception in 1949 and by opposition leader Sussan Ley from 2001 until she was ousted by Mr Taylor in a February leadership spill.
Mr Farley was mobbed by a press pack entering Albury Public School shortly after voting began at 8am.
"I've got three clear jobs to do: I've got to win today, I've got to make sure we're ready for the next election and I want to help Pauline Hanson and her team build a powerful political party for Australia," he told reporters.
Attending a voting centre in Jindera, Ms Milthorpe rejected criticism from opponents over funding received from Climate 200.
"It's just lazy rhetoric by parties who are scared and threatened by people who want to do things differently," she told reporters.
"At the end of the day, everyone needs to be funded for their campaigns.
"I'm open and transparent about where mine comes from and my positions are informed by the people of Farrer."
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