You must open the files from the remote side.
Sounds like you are using the FTP Client tool-window which is used to download remote-to-local and upload local-to-remote.
You probably want to use the FTP tool-window (File>FTP>Activate FTP).
If you want to have a local copy of your remote tree for the purposes of project/tagging, then what you did in steps 1-3 is fine, but you should additionally set up a Remote-to-local directory mapping:
Edit your connection profile, Advanced tab, "Remote to local directory mapping", select Help.
You will want to map the root of your SFTP remote tree to the root of your local project tree.
Example:
Remote: /my/remote/dir/project1
Local: /Users/lahughes/build/project1
Opening a file (from the remote side) will then download/overwrite the file in the mapped local directory, maintaining the same directory structure.
And because you specified the mapping in your connection profile, the local copies will not be automatically deleted when the file is closed.
++rodney