If this is the first year you will report your Rental Property, you could add your Improvements to your Purchase Price to determine your Cost Basis for Depreciation.
You would report your Casualty Loss for a Business Property, using a Value Before of $7,700 and a Value After of $0. The difference between the $7,700 you spent to restore the property and the $10,500 you received as an insurance settlement would then be reported as a Capital Gain.
Click this link for info on Insurance Proceeds for a Rental Property.
This article has detailed info on the difference between Improvements and Repairs you may find helpful.
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