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The court voted 5-4 to grant a Trump administration request to lift injunctions blocking the policy while challenges continue in lower courts.
The four liberal judges on the court opposed the ruling.
The policy prohibits "transgender persons who require or have undergone gender transition" from serving.
The top court's ruling is not a mandate, but it has opened up the option for the military to enforce the ban.
The Trump administration had also appealed for an expedited ruling on the case, which the Supreme Court declined to take up.
The president announced on Twitter in 2017 that the country would no longer "accept or allow" transgender Americans to serve in the military, citing "tremendous medical costs and disruption".
The then defence secretary Jim Mattis refined the policy to limit it to individuals with a history of gender dysphoria, or when a person's biological sex and identity does not match.
He said the new policy would make exceptions for several hundred transgender people already serving openly or willing to serve "in their biological sex".
There are currently some 8,980 active duty transgender troops, according to Department of Defence data analysed by the Palm Center, a public policy nonprofit.
Gen Mattis in his memo argued that "by its very nature, military service requires sacrifice," and that those who serve "voluntarily accept limitations on their personal liberties".
The move is a reversal of an Obama administration policy that ruled transgender Americans could serve openly in the military as well as obtain funding for gender re-assignment surgery.
Aaron Belkin, director of the Palm Center, told the BBC: "We had an inclusive policy for almost three years. What today's ruling enables is the whipsawing of policy, back and forth." (BBC)
• People protest President Trump's announcement of plans to reinstate a ban on transgender individuals from serving