Prime Minister Anthony Albanese said his government would work with Rex administrators to find a buyer committed to providing ongoing service to the regions, value for money and good governance.
If that falls through, Labor will begin working on contingency plans including preparations for a potential Commonwealth acquisition.
"The collapse of Rex ... endangers access of these regional communities throughout Australia to our capital cities and to the connectivity that is so vital for the quality of life, so vital for these local economies as well," Mr Albanese told reporters in Merimbula, on the NSW south coast.
But the Regional Aviation Association of Australia, which represents over 40 regional airlines and charter operators, believes the rest of the sector can provide the services needed without Rex.
Member carriers, including QantasLink, Airnorth and Nexus, already compete with Rex on 21 out of 46 routes, and with appropriate government support could pick up the remaining services, RAAA chief executive Rob Walker told AAP.
"We ask the government to continue to consider all regional airline operators during the Rex sale process," he said.
"The potential government ownership of one regional airline could lead to an an inequitable situation across the regional aviation industry."
Deputy opposition leader Sussan Ley blamed the Albanese government's "failure of management" for allowing Rex to go under in the first place.
"Governments shouldn't own airlines," she told Sky News.
"Because that means that taxpayers own them and taxpayers pay for them."
Mr Albanese said governments had to intervene in the aviation sector and look out for regional communities when markets failed, citing examples of public-owned airlines internationally in the Middle East, Singapore and New Zealand.
"There's a reason for that, because aviation plays a critical role in communities," he said.
During the previous coalition government, Rex received substantial Commonwealth support in the form of JobKeeper payments and direct funds, Mr Albanese said.
But without strings attached to the payments, Rex expanded beyond its means into capital city routes, leaving it in a "financial mess" that the government now had to deal with.
Nationals leader David Littleproud was more supportive of the government's proposal than his coalition partner but said nationalising Rex should be an option of "last resort".
"Can it be run over different routes by different airlines, I think everything needs to be on the table," he told Sky.
"But the guiding principle is that we need a service and it's been proven to be viable if you get the foundations of it right."
This will be the second attempt to sell Rex after it fell into voluntary administration in mid-2024.
Federal Transport Minister Catherine King said it was evident through the first sales process that without government support, a private sale was unlikely to be successful.
Questions were raised over the government's role in Rex's future after spending $130 million to take over its debts and ensure the carrier could run regional routes until the end of June.
Should Rex be nationalised, it would be the first time a federal government has owned an airline in three decades, after Qantas was privatised in 1995.
The Transport Workers' Union said nationalising Rex would be a significant turning point in building an aviation industry for the "public good".
"This is a vital step towards a future where aviation actually works for the people of this country, not its overpaid executives," national secretary Michael Kaine said.
Rex's regional flight slots at Sydney Airport have been guaranteed until October 2026.
The government will also spend $12 million to upgrade regional airports across NSW.
This includes a $3.8 million investment in Merimbula Airport's runway extension, $5 million for runway upgrades at Albury Airport and other commitments at Mudgee, Griffith, and Moree airports.
