That's a good question. I don't have a definite answer for you but here are two things to look at.
this thread says you should report it as a sale of real estate in the year you paid the settlement with zero basis, thereby creating a capital loss.
https://ttlc.intuit.com/community/tax-credits-deductions/discussion/how-do-i-deduct-legal-settlement...
That thread does not explain WHY you can do that. Perhaps it is because of I.R.C. 1341 relating to prior year income that you thought you had a right to ("claim of right") but later found out was challenged and you returned/repaid some of it. I am not sure it applies in your case but you might research it. I think (but am not certain) that you might even be able to get around the $3k capital loss limitation with a 1341 deduction.
See as a starting point
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