Before commenting on this key verse, allow me to make a few observations about two verses which can cause more than a measure of concern to the eager-to-please reader — consider verses 6 and 9. You read these verses and exclaim, "I'm in trouble here! Because I'm sinning every day." Let me help you.
In both verses, sin is described in the context of habitual and continual sin — that is, sin which is wilfully embraced day by day. John refers to those who "continue to sin" while professing victory over sin (for sure, he's thinking of the Gnostics here). He's not thinking of human failure, but rather he's addressing committed hypocrisy. If you "live in" Christ (6a) and have "God's seed" (9b) living in you, then you'll find yourself combatting rather than embracing sinful behaviour. For those who "continue to sin", there is no struggle or fight; it's part of their lifestyle. For those who have "been born of God", sin is a real issue that needs to be fought and conquered in Christ every day. The former accept sin, the latter fight sin. But everyone does sin.
And, when your heart condemns you (as it surely will from time to time), remember this: God is greater than your heart. While you may be condemning yourself, God may be lovingly reaching out to remind you of the ongoing work of Christ's blood in your life (1:7). He knows the dark realities of your past and the struggles of your present. He can be trusted to deal graciously with all who put their trust in Him.
Lord, God, You know every one of our thoughts, words, and deeds, and "You love us. We determine to set our hearts at rest in the knowledge of Your gift of cleansing from all sin through the cross of our Lord Jesus Christ.