Around 2010 the city storm drain caused damage to my house, and in 2013 I received a settlement which is enough to partially pay for repairs. The city paid my attorney, who then deducted contingency fees, and then the attorney paid me the remaining amount for repairs. The settlement agreement with the city does not specify how the money is allocated (for damages, nuisance, etc.) I'll probably get a 1099 in January.

I am confused about what IRS forms I will need to fill out, since I always do my own taxes using TurboTax. I am pretty sure that the best tax treatment will be to offset this 1099 amount with the reduction in basis to the property, since the house has a lot more basis than the damages.

One of the IRS publications says that when the damage payment reduces the basis of the property, it is not considered income so it is not reported on the return. But that's where I am completely confused. If I receive a 1099, then the IRS will see a 1099 "income" source. How can I not report that according to the IRS guidance? There must be some other form I fill out somewhere to offset the 1099 "income" so that it is cancelled out as income and becomes a reduction in basis instead.