Ancelotti, who worked with James, 28, at both Madrid and Bayern Munich, is keen to sign the Colombia international.
But Partenopei president Aurelio De Laurentiis has told Madrid it will have to lower its demands for James, who appears to be surplus to requirements for Los Blancos.
De Laurentiis is confident a deal can be struck, however, while Napoli boss Ancelotti has already been in contact with the playmaker.
"James can play in many positions behind the centre-forward," Ancelotti said after a pre-season loss to Benevento. "He is a number 10 used to playing behind the striker or as a winger, with the tendency to cut inside.
"I sent him a happy birthday message this week. There are negotiations in progress, it's going to take a very long time, but we aren't desperate or anything.
"If it doesn't work out, we'll still be a strong team and might go for a different target."
Napoli has also been linked with Mauro Icardi, who has been told he can leave Inter Milan, but Ancelotti indicated he is satisfied with options in attack that include Lorenzo Insigne and Dries Mertens.
"As for the striker, a modern centre-forward can't just be a finisher now, which is why Arkadiusz Milik is very important for us," the Italian said.