Very doubful that this is teflon tape. Teflon tape is used on the threads of pipe joints to prevent the joints from leaking. It is not inside the pipes. Also, from the description you give, I'd suspect the dip tube in the water heater. These are replaceable, but it may not be worth the cost if the tank is as old as the house. The the heater is only a few years old, then repairs would be in order.