AS we have all seen, when you are near an Oblivion Gate, the sky turns from blue to red with quick-moving clouds and lightning storms. The sky of Oblivion.

I noticed that when you get further away from the gate, the sky very slowly fades back to normal. No matter how far away you get. I could get half-way across Cyrodiil and the sky would still be fading away. This made me question whether the sky actually changes at all or if it is some sort of illusion given off by the gates.

So... is it an illusion? Where the world doesn't change, but the beholder simply sees this illusion? Or does the sky genuinely change in an area around the gate?

The sky as mortals perceive it is an illusion, to begin with. Even in its normal state.
It's the void of Oblivion at night, and at day, it's outshined by the light of Aetherius (the sun). What mortals see is the direct result of overstressed, limited senses trying to perceive something limitless.

I heard someone say that Magnus was the sun...? Or is that wrong?

Magnus teared the hole into reality that is the sun. The sun is a portal to Aetherius.