People forget that 18 year olds are inherently naive and immature.

What your sister suggested is obviously the byproduct of being exposed to hypersexualized media and the glorification of incest in film/porn. This, combined with the fact that she has a great older brother whom she looks up to, has led her to confuse her feelings of respect and familial love for sexual attraction.

Bottom line, do NOT shut her out forever (unless she starts trying to act inappropriately, then get your parents involved). Instead, sit her down and tell her that: 1) as her brother, you will NEVER have a sexual relationship with her 2) what she sees in you is what she likely is searching for in a partner, so she has to realize that she must find these qualities she admires in someone else 3) you will always love her as a brother should, in a FAMILIAL way. You will never cross that line

Having an open conversation is better than hiding away because she might see you ignoring her as a sign that you yourself are also having conflicting feelings. Nip this in the butt now!