I'm trying to drop all packets from the internet that use a fake ip address so they appear to come locally.

Do I need both lines or only the first ?

--append INPUT ! --in-interface lo --source 127.0.0.0/8 --jump DROP

--append INPUT ! --in-interface lo --destination 127.0.0.0/8 --jump DROP
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You should consider setting /proc/sys/net/ipv4/conf/all/rp_filter. See here linuxsecurity.com/content/view/111337/65 for a description. – ceving Jun 3 '11 at 17:56
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You could use both, neither should exist really so blocking shouldn't hurt.

I'd also add rules for blocking non-routing IPs coming from outside your network.

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