The "official" IRS instruction when you receive an incorrect 1099 is to file by mail, and attach a copy of the 1099 and a written explanation. In this case, presuming that PayPal account sends a 1099-K for your personal account indicating receipt of $26,000 that is not actually your personal or business income, you would leave it off your return, file by mail and attach a written explanation of why this is not personal taxable income. (This would be similar to if you received gifts in your personal account that were not for work performed, such as gifts to pay medical expenses from a crowdfunding campaign.)
Of course, filing by mail is slower. I don't understand your explanation of #2, you can't take an itemized tax deduction and I don't know what other kind of deduction you are thinking of. #1 and #3 are both valid, although both may result in an IRS letter, to which you will respond with the same kind of written explanation.
