First of all I want to thank you for your question, because I am sure other people are going through a similar situation.
As you said, your best friend is like your sister, which means you are extremely close. When you are so close to someone, it is natural to be physically affectionate with them, just as you are with her.
It is also commonplace to have the sort of fantasy dreams that you have been experiencing, even if there is no sexual attraction to her. Dreams can be interpreted in many ways, and just because you are dreaming about her in this way has nothing to do with your sexual orientation or even sexual feelings towards her.
It is probable that the dream(s) are just an extreme manifestation of the friendship and bond you two share. The sexuality in the dream may just be representing the closeness you have with her. However, it is also possible that you do have erotic feelings for her, although this does not necessarily mean you are bisexual or lesbian. You could define yourself as a lesbian and have some small degree of sexual attraction to men and vice versa, i.e. define yourself as a heterosexual but have some degree of sexual attraction to women. Also, being sexually attracted does not mean you have to act out all your sexual fantasies.
In terms of telling your friend, the best would be to test out first how open she is to consider same-sex attraction/relationships. You could mention a story about a same-sex couple or point out to her people in the streets who are obviously in a same-sex relationship, thereby monitoring her reaction to this idea. Then, if she seems to be quite open and accepting, you could consider telling her.
Of course, I cannot tell you whether you are definitely gay or straight or anything in between; this is something that ultimately comes from inside you. You also don’t have to define/label yourself in any way. As I have mentioned before, same-sex attraction si actually very common, although not all individuals experimenting it will end up defining themselves as gay.
Hopefully this answer was helpful to you! If you have any other questions, please write back!
Catherine, for AlterHeros