Australian police on Wednesday said it thwarted an imminent attack linked to the Islamic State after arresting two men from a house in Sydney during anti-terror raids.

The duo, aged 24 and 25, were on Tuesday arrested in a raid carried out by NSW Police and Australian Federal Police at a house in the western Sydney suburb of Fairfield following a tip-off that they were planning an attack.

Police seized a machete, a hunting knife and a flag associated with Islamic state along with a video of a man talking about carrying out an attack.

The accused have been charged with preparing to commit a terrorist act. NSW Deputy Commissioner Cath Burn said the men appeared to be planning to harm or kill someone by "using one of the items recovered (in the raids), potentially a knife".

Police believed the attack was going to occur on Tuesday.

She said the video showed one of the two arrested men making threats. "One of the men indicated an attack as going to be carried out," she said.

On a query if if the men were planning a beheading, she said, "We don't really know what act they were going to commit."