Consult a qualified tax professional.
However, I believe that:
- If you perform the improvements, any difference in the amount you pay and the amount of the settlement would be added to your cost basis in the property.
- If you do not perform the improvements, any settlement you receive would be subtracted from the cost basis in the property.
In either case, this shouldn't affect your taxes this year. However, you'll want to keep records of everything, as it may affect the taxes due when the property is sold one day.
Again, consult a tax professional for reliable advice. These are large amounts of money you're talking about, and you shouldn't trust it to the internet.
