I wish to do a clean format of my iMac and upgrade it to Mountain Lion. It's hard disk capacity is 1TB. Is it possible for me to restore the data from the Time Capsule to my iMac by connecting the two via a USB cable?
No; you need to use Ethernet or wireless.
Ethernet is faster than USB.. and you can simply reset the TC and plug it direct to the Mac any other network connection if you wish. Reset does not harm in any way the data on the hard disk.
Retrieving data ...