The prime minister says he will be joined by Foreign Minister Penny Wong, the first openly gay woman in parliament, when he takes part in the event later in February.
"I'll be the first prime minister not to watch the march on Mardi Gras, but to march," he told a crowd at the official opening of Pride Square at Newtown, in Sydney's inner west.
In 2016, Malcolm Turnbull became the first sitting prime minister to attend the Gay and Lesbian Mardi Gras, but he did not march in the parade.
That year, then opposition leader Bill Shorten became the first federal leader of a major party to participate in the march.
Mr Albanese said on Saturday his government was committed to removing inequality on the basis of sexuality or people's identities.
"We speak a lot about tolerance - and tolerance is really important - but this is about a step that is way more important than tolerance," he said.
"We need to celebrate our diversity, not just tolerate it, because our diversity is what gives our society strength."
Mr Albanese paid tribute to protesters who marched for gay rights in 1978, many of whom were arrested when the first parade on Sydney's Oxford St was dispersed.
Since then, the annual Sydney march has grown to become part of one of the largest LGBTQI festivals in the world.
This year, 12,500 marchers are expected to participate as the parade is incorporated into the 17-day WorldPride festival.
Mr Albanese said Australia could be "a beacon for the world", where everyone would be respected and celebrated regardless of their beliefs, sexuality or ethnicity.
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