Here is the background of our question:
1. 2009 Personal injury lawsuit was awarded; however the perpetrator had cashed out his bank accounts. The judge awarded my daughter the perpetrator's primary home. She subsequently sold it in 2012 on a land contract, and her attorney agreed to wait until the 3-year balloon ended to collect his fees. She is still owed a substantial amount which will never be collected, due to the death of the perpetrator.
2. The sale was reported in 2012 to the IRS, they accepted the documentation of the lawsuit and determined the sale to be a non-taxable event.
3. The buyer pays faithfully, my daughter makes about $6,000 per year on the interest from the land contract. We provide the buyer with a statement at the end of each year, and I assume that she claims the interest as a deduction.

Here is the question: Is the interest that she is collecting on the house still part of the lawsuit proceeds and thus non-taxable? If so, where should it be reported?

Well with 57 hits and no answers, I called a pleasant level 5 HR Block representative who indicated that interest on the land contract could not be considered part of the lawsuit proceeds. She said that she was surprised that the IRS allowed the house to be a non-taxable event (I explained that I was advised to make the basis the same as the sales price, and to keep my paperwork about the lawsuit with my taxes to show the award) and that the interest from the land contract would always be considered income, since it was not required by the court to be included in the proceeds. (Additionally it could be claimed by the buyer on her taxes on Schedule A as a deduction.)