The OS, dubbed Brillo, is likely to be released under the Android brand. It will target low-power devices with as little as 64 or 32MB of RAM.
The Information reported that the lower memory needs for devices running the new software may result in a sharp decline from the new versions of Android, which are mainly intended for mobile phones with about 512MB of memory.
Companies can build smart fridges, light bulbs, garden monitors and many more with the help of the new technology.
The code for the new OS is expected to be launched next week at Google I/O conference.
IDC forecasts the IoT market to reach $3.04 trillion by 2020 and Gartner estimates that the number of networked devices will increase to 26 billion units by end of thi decade.
IoT acquisitions topped $14.8bn in the first five months of 2015, up from $14.3 billion for the whole of last year.
Buyers have purchased 39 IoT-related firms since January, less than the 62 in 2014 but with more expenditure involved.