Because hallucinations seem so real to those with Alzheimer's, it is not helpful to try to convince them that they are imagining things. Instead, acknowledge your loved one's feelings, try to reassure her that you are there to help, and redirect her to a pleasant activity.
Another thing to consider is whether the hallucination is actually bothering your relative. If it's a pleasing hallucination -- for example, your loved one sees birds and flowers outside a window that are not really there -- there may be no benefit in trying to discourage or minimize the behavior.
Sources:
Behaviors: What causes dementia-related behavior like aggression, and how to respond. Alzheimer's Association. 2005. http://www.alz.org/national/documents/brochure_behaviors.pdf
Mace, N. L., & Rabins, P. V. (2006). The 36-hour day: A family guide to caring for people with Alzheimer's disease, other dementias, and memory loss in later life (4th ed.). Baltimore, MD: Johns Hopkins University Press.
