Unfortunately, the total settlement is $40,000, and you can't take a tax deduction for personal legal fees.
Also, the $28,000 you say you have paid so far probably includes interest or finance charges, that does not count as part of your cost basis. Your cost basis includes what you have paid for the car, including legal costs that are mandatory regardless of financing (like sales tax and other government fees) but not financing.
If you receive more than your cost basis, that is a taxable gain. As long as you had the car more than one year, it is a long term capital gain which is taxed at a lower rate than ordinary income. Report the transaction as if you sold the car to the manufacturer for $40,000. Subtract your cost basis (what you paid not counting interest) and the difference is taxable income. You will pay a lower capital gains tax rate on your federal return, but California does not have a discounted tax rate for capital gains so any gain will be added to your other regular income for state taxes.
