At the current market price of the stock, that stake would be valued at about $1.5 billion.
The government owns 68.6 per cent of IOC, whose stock hit a record high in July and has outperformed the broader market this year as the refiner benefits from cheaper global crude prices.
It will sell about 242.8 million shares in Indian oil in Monday's auction, for which it will set a floor price on Saturday.
Individual investors can buy the stock at a 5 per cent discount to the final bid price, the government said in a regulatory filing.
New Delhi is seeking to raise as much as $11 billion by selling stakes in state-run companies this fiscal year, crucial to narrowing the fiscal deficit to a planned 3.9 per cent of gross domestic product in 2015/16.
The government has missed its divestment target for the last five years in a row.
Last month, the government raised about $260 million from the sale of a 5 per cent stake in Power Finance Corp Ltd , after the auction received bids for more than twice the number of shares on offer.
Citigroup, Deutsche Bank, Nomura and Indian investment banks JM Financial and Kotak Securities are the managers of the Indian Oil share sale.
Indian Oil, RIL, Tata Motors among world's 500 largest firms