Raul had been in charge of youth sides Cadete B and Juvenil B, and will now take on the top job in Madrid's famed academy.
Castilla - Los Blancos' B team - currently play in Segunda Division B - Group 1, having lost out to Cartagena in the promotion play-offs last season.
Current Madrid coach Zinedine Zidane also started his senior coaching career with Madrid's Castilla side, with Santiago Solari having followed a similar path.
"Raul Gonzalez Blanco will coach Castilla for the coming season," Madrid revealed in a statement released on Thursday.
"Raul, who this season was trainer of the Cadete B and Juvenil B, will begin a new professional spell in Real Madrid.
"A legend in Madrid, Raul played in the Real Madrid first team for 16 seasons, in which he won three Champions Leagues, two Club World Cups, one UEFA Supercup, four Ligas and four Supercopas."
An academy product himself, Raul was a key figure in Madrid's first team between 1994 and 2010, becoming the homegrown symbol of the Merengue in an age dominated by expensive imported Galacticos such as Zidane, Ronaldo, David Beckham and, towards the end of his time at the Bernabeu, Cristiano Ronaldo.
Raul's professional career ended with stints in Qatar with Al Sadd and at North American Soccer League's New York Cosmos, before he finally hung up his boots at the age of 38 after delivering a treble for the club.
He remains Madrid's second-highest goalscorer with 323 strikes in official competition, with only Cristiano netting more in club colours than the 41-year-old.