Yes the items are still listed as categorical and yes there are residual variances.
There is an error message stating "the standard errors of the model parameter estimates may not be trustworthy for some parameters due to a non-positive definite first order derivative product matrix. this may be due to the starting values but also may be an indicator of model non-identification'.
I also re-ran the EFA with WLSMV with the item that has negative residual variance removed. When I do this, the 2 factor solution has acceptable fit and no negative residual variance - I am considering just reporting this model. Is this appropriate?
Removing items with negative residual variances is a questionable approach. It isn't necessarily the item with a negative residual variance that is the ultimate cause of the problem and often removing one item makes the negative residual variance show up somewhere else. But if you don't need the item, the decision is yours.