<p>I agree that it’s best to do it as honestly as possible. A few don’ts to avoid in your situation. I HIGHLY doubt you’d do anything like the points below judging by the fact that you asked for advice on how to be nice about rejecting someone; however, I figured that it doesn’t hurt to bring up a few things to avoid doing at all costs, even if some of them come off as dead obvious or far-fetched:</p>
<ol>
<li><p>Don’t tell her you’re not interested over the phone or online. Everything you say will sound about ten times harsher if you do it that way.</p></li>
<li><p>Don’t waste your breath with long excuses of why you’re not interested. It’s enough for her to know without hearing fifty reasons for it. In fact, reasons will sometimes make it worse because they can cause her to question aspects of her person (ie: “I don’t find myself attracted to you in that way” could make her question whether she’s attractive “in that way” at all).</p></li>
<li><p>Don’t tell her in a public situation where you could be overheard or won’t feel comfortable speaking to her honestly and openly. There’s no point to draw attention to what is fundementally a rejection for her.</p></li>
<li><p>Don’t tell her you’re not interested because you have your eye on someone else. Doing so absolutely crushes her ego, particularly if she knows the other girl. And it leads to all sorts of unpleasantness such as jealousy.</p></li>
<li><p>And above all, I agree with theasianmadman, avoid making it painful at all costs. Make it short and sweet and be sure to say something positive along with the rejection (ie, the ever-cliche “I really value our friendship”).</p></li>
</ol>