"Zinedine Zidane will manage Castilla next season," Real Madrid said in a statement on the club's website.
"Zizou, who was Carlo Ancelotti's first squad assistant coach this year, will start a new stage of his career at Real Madrid.
"Zidane will be joined by youth coach Santiago Sánchez and has already started working on future plans for the reserve team squad."
Castilla were relegated to the Spanish third tier last season, but may be reinserted into the second division if sanctions are taken against Zaragoza and Murcia for financial transgressions.
Zidane, 42, played for Cannes, Bordeaux and Juventus before joining Real Madrid in 2001 and retiring at the age of 34 after the 2006 World Cup.
He became France's playmaker in the buildup to the 1998 World Cup on home soil and earned legendary status with two headed goals in the 3-0 win over Brazil in the final.
Four years later injury spoiled his World Cup in South Korea and Japan, but he was instrumental in leading France into the 2006 World Cup final in Germany against Italy only to be sensationally sent off for headbutting defender Marco Materazzi in the chest before the Italians won on penalties.
He had recently been linked with the vacant managerial job at his former club Bordeaux, but elected instead to stay at Real where he is regarded as one of the club's finest ever players.
He enjoys a close relationship with Ancelotti and will now be in charge of developing younger players for first team duty. He would also be ideally placed to take over from the Italian when he decides to move on.
Ancelotti said of his assistant in May: "He is learning how to work as a coach. He is hard-working, he has charisma and the right kind of personality to succeed.
"He is learning how to programme training sessions, how to talk to the players, how to motivate them and a a consequence of that I think that he is ready to take over as coach at any team."
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