Both Forms 1099-R must be entered into TurboTax.
For the code G Form 1099-R, TurboTax only needs to ask about rollovers to Roth-type accounts. If you answer No to both Roth questions, TurboTax knows to treat the distribution as a nontaxable rollover without asking any other questions because code G already indicates that the distribution was rolled over.
It's correct that $7,000 is the amount of income that is reportable on your tax return in the sense that both distributions must be present on your tax return. You'll see $3,500 included on Form 1040 line 5a for the code-G rollover but this entire $3,500 excluded from the taxable amount on line 5b. The word ROLLOVER will also appear next to line 5b to indicate why the taxable amount distributed from 401(k) is less than the total amount distributed from the 401(k). You'll separately see on Form 1040 line 4b the $3,500 taxable distribution from the IRA.
