Fantasy works often deal with a number of sentient creatures, ranging from subtly to overtly distinct from humans. The classics are elves, dwarves, orcs, and usually at least one flavour of small humanoid, typically at least goblin, and occasionally something more like a typical human, just in miniature, variously called hobbits, halflings, gnomes, boggles, fae, changelings, or the like.
Thanks to the influence of Tolkien which touches all western fantasy works–even when a concerted effort to avoid its influence is made–these are typically called races. It was the 30s, Tolkien was a product of his time, and race wasn’t such a problematic term.
The problem with the term race is that it is now recognized to mean virtually nothing. It is a social construct made to categorize groups of humans with similar pigmentation, hair texture and bone structure. If you take a person who has dark skin, and a person with light skin, they are still genetically identical save for a handful of alleles. If you were to take the ruddiest skinned “white” man, and the lightest skinned “black” man, the white man would actually be darker than the black man, but their respective “races” would still consider them to be “white” and “black” (social prejudices aside).
The clear alternative term is species. This has other problems. The first is that, to the lay person, things are different species if they cannot produce fertile offspring together. A horse and a donkey can produce a mule, but mules are sterile. This makes the term less than ideal in fantasy because humans can often produce fertile offspring with, at least, elves and orcs. Sometimes they can produce fertile offspring with giants or ogres or trolls even. It depends on the setting.
So if humans can produce children with elves and orcs, then maybe race, or better– due to lack of social baggage–breed, works, right?
The problem is that a human can have a child with an elf, and that same human can have a child with an orc, but the orc and elf cannot, typically, breed with one another. I think this would be false in Tolkien, actually, because, if I recall correctly, the orcs were corrupted elves, I’m not sure (I never actually read the Lord of the Rings books in their entirety).
The other issue is that, ok, sure, elves and orcs can be easily said to be breeds of humans, and if you want, you can say that they can interbreed with one another as well so as to fix that problem. But what about elementals or dragons? In at least Dungeons and Dragons, it’s possible for creatures which are sentient collections of pure elemental energy to impregnate a human, or an elf, or dwarf, or whatever else and produce a viable offspring. In a lot of fiction where dragons are themselves sentient, they can do likewise.
It’s really hard (though admittedly not impossible) to say with a straight face that humans, elves, dwarves and orcs are genetically related to dragons. It is fully within the author’s power to say that the sentient races are descended from dragons, and sometimes this tack is taken.
The best solution, at least for the direct problem of elves, orcs and humans, is found in calling Humanoid a ring species, and then terming the individual types breeds, or even races. A ring species is basically a group of closely related populations of a single species. Each population can interbreed with one or more others, but there are some which it cannot. In the given circumstance basically you’d have the populations Orcs, Humans, Elves. Humans are closely related to both Orcs and Elves, and thus can interbreed with both, but Elves and Orcs are too distantly related to interbreed. This could become more of a web-species if additional populations were added which could interbreed with humans, but not others.
There is one final problem with the use of the term species in fantasy.
Eventually you will want characters to talk about these classification in story/world. While it’s fine for erudite wizards or technomages or fantasy anthropologists to use the term species, it’s just weird to here tribal, berserker-focused cultures use the term. Even more so for, say, goblins. But that’s easily dealt with. A berserker can say race or clan, and people should be capable of understanding that that is just the way his culture expresses the idea. A goblin probably says clan, and probably uses the term for both actual family-related groups of people and in place of species.
The other problem is certain magical creatures demonstrably and drastically unrelated to the humanoid species being able to produce half-dragons and fire elemental humanoids and such. That’s, well, magic. Lame cop out I know, but it’s the easiest solution.