Senegalese winger Sarr, 22, joined Watford last year from Rennes for a club-record fee.
His most striking performance of the season came when Watford destroyed eventual Premier League champions Liverpool.
Sarr scored two goals and assisted the other in a 3-0 win over Liverpool in February.
Palace scored only 31 goals in 38 league games in the 2019-20 season and face losing star man Wilfried Zaha.
Sarr would be a natural replacement for Zaha, should the 27-year-old Ivorian move on.
Coman in talks to join
Meanwhile, Palace are in talks to sign highly rated FC Steaua Bucharest winger Florinel Coman.
Romanian journalist Emanuel Roşu revealed that the 22-year-old’s agent is in London to negotiate a deal.
FCSB value the three-time Romanian international, compared to Kylian Mbappé by Gheorghe Hagi, at €15m.
Coman hit double figures in both goals (15) and assists (11) in all competitions this season.
BREAKING: Florinel Coman's agent Ioan Becali is in London to negotiate his transfer to Crystal Palace. Coman, nicknamed 'Mbappe' after Hagi compared him to the French diamond, is priced at 15m euros by FCSB owner Gigi Becali.
— Emanuel Roşu (@Emishor) August 10, 2020