I have not been able to sell my former home in this real estate market. I rented it in 08 at a monthly loss to a family who wants to buy it. I am willing to apply their rent payments to their purchase of the house. How do I report the income in taxes? How does it affect my taxes when we complete the sale in 09?

You can do this, but, in doing so, you lose any tax break associated with filing the house on Schedule C, because the payments are NOT rent, but rather installment payments on the ultimate sale of the house.

You should get local professional tax help for 2008, because there are a number of variables to consider in this scenario.