Update:
I have found several sites that indicate the rebate is indeed taxable, and I have not found any site that supports my argument about basis. So you would go with answer #1, write a letter and include documents that this was a turf removal rebate, not work or services that you performed, so is it taxable but not "Self-employment." Likely the computer that generated the letter only saw a 1099-MISC and decided to challenge it, and did not look into what it was for.
However, the rebate is NOT taxable on your California return. There is a procedure in Turbotax to include the rebate in your taxable federal income but then subtract it from your state return. If you included the rebate in your state taxable income, you may be able to file an amended state return to remove it and claim a refund.
