"General Dustum has been appointed as the chief of staff of the High Command of the Armed Forces," President Karzai's spokesman Jawed Ludin told journalists.
However, Ludin added that Deputy Defence Minister Bism Allah Khan will retain day to day management as the Chief of Army Staff in command of the nation's 25,000-strong army.
The decision - likely to be announced on national TV on Tuesday night - may alarm rights groups who have been calling for those who committed war crimes during the country's bloody civil war to be brought to justice.
Dustum, one of the most powerful men in northern Afghanistan, contested against Karzai and won 10% of last October's presidential vote, mostly in northern provinces where he garnered much support from the ethnic Uzbek and Turkmen communities.
However, he was named by the Afghan Independent Human Rights Commission for the violence of his troops during the civil war which raged in the Afghan capital between 1992 and 1995, and for his bombing of Kabul during that period.
Karzai's spokesman Jawed Ludin did not say if Dustum had been made the country's military chief, but hinted that he would be given a key post.
"I think General Dustum will be offered a very good, respectable and appropriate job within the government"
spokesman for Afghan President Hamid Karzai
"I think General Dustum will be offered a very good, respectable and appropriate job within the government," Ludin said.
Ludin insisted that Dustum's appointment to a government post was "a good thing, a positive one".
Dustum played a major role in overthrowing the Soviet-backed communist government of which he himself was a part for many years. During the subsequent civil war era, he switched sides between rival mujahidin commanders.
As the Taliban conquered large swathes of the country in the mid-1990s, Dustum fled to Turkey. After US-led forces ousted the government in late 2001, he reappeared in possession of tanks and heavy weapons.
He has now ceded most of them as part of a UN-backed disarmament drive.
An ethnic Uzbek, he was appointed as Karzai's envoy to the north soon after the fall of the Taliban and an adviser to the Defence Ministry.
In January, Dustum narrowly escaped assassination by a bomber outside a mosque in the northern town of Sheberghan, where he had been reciting open-air prayers on a Muslim festival.