James has been a stalwart of United's squad since the club was formed ahead of the 2018-19 season. She scored their first goals in the Championship and the Women's Super League and was the first woman to score at Old Trafford.
The 19-year-old has been linked with a move away from Manchester for several months, with a return to London the top target.
United confirmed in a statement that Hannah Blundell's move to the Manchester club, which was announced earlier in the day, was part of the deal with Chelsea for James.
"It's a great feeling to come back home, to a great club, the club I started at the age of six," James said in a statement on Friday.
"To be able to play for the first team now and come back here to [Chelsea coach] Emma [Hayes] and the rest of the group is a great feeling.
"I'm excited to get started and I can't wait to meet all the fans at Kingsmeadow when the new season kicks in."
The Guardian have reported that her transfer is record-breaking for involving the most money ever exchanged between two WSL clubs.
"Lauren is an exciting, young talent who we have admired for a while," Hayes said.
"When the opportunity came up to sign her, we felt now was the right time to bring her back to the club.
"We're excited to see how she develops in the coming years and look forward to welcoming her to pre-season training."
She played with both Chelsea and Arsenal at youth level and made her senior debut for the latter when she was just 15.
The striker then moved down to the Championship with newly formed United and scored 14 goals in her first season, helping the side to WSL promotion at the first time of asking.
Injury hampered parts of her 2020-21 season but she leaves the club as their second all-time top scorer with 28 goals. Ella Toone leads the way with 32.
James is the latest in a number of high profile names to leave the club with USWNT World Cup winners Christen Press and Tobin Heath both returning to the National Women's Soccer League and manager Casey Stoney resigning.
The Athletic have reported that there has been anger amongst the squad over the facilities and care given by the club to the women's side which is still without a manager after Stoney's departure.