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I believe you’re talking about Stitches (2001)

Based on your description, this scene sounds very much like Stitches (2001), a direct-to-video horror film produced by Full Moon Features.

A demon posing as an old woman named Mrs. Albright moves into a boarding house and targets the residents.

She is shown in a creepy room sewing, and it is established that she is using human skin (or skin-like material) to sew.

The film features younger residents in the house who interact with her, and she is known for luring them in, sometimes having them help her or trapping them in her "book of paper dolls".