Thank you for your response. Here are some additional facts that I omitted.

filed bk Feb 11', discharged May 11'; case closed Jan 12'. rental home purchase in 08 @ 150k', depreciated 15k since. Value of rental at time of filing was 120k. There are no NOLs. 40k in cc debts discharged.

My cpa is new to tax returns with bankruptcy & reduction in tax attributes. She says I have to reduce the rental basis by the discharged cc debt of 40k. (135-40) to 93k.

Assume I sell the house at the loan balance of 128k, all of which goes to the bank to satisfy the loan and I get zero.

Per cpa and tax purposes, my gain is 35k (128-93) and I have to pay at ordinary income.

Question - Why? Yes I walked away debt free from ch 7 discharged, BUT the bank got all there money back. I made no money? Again if I got the discharge AND got the house free, I would gladly pay cap gains upon selling.

2 - What does the discharged cc debt have to do with reducing my cost basis in the rental?

3 - What should the correct reduction in basis be? Per cpa using the discharged cc debt does not sound right.

Take a look at IRS Publication 4681 (http://www.irs.gov/pub/irs-pdf/p4681.pdf), specifically the section on tax attributes on principal residences. It should clarify things for you more. Your question is 99% tax-related, not bankruptcy, so if you still need advice, I suggest talking to a tax attorney.

Mark is correct.

Also just found out that per section 1017 of the Internal Revenue Code, if you claimed the property as exempt on your bankruptcy papers, you are not required to reduce the cost basis upon discharge. I'm not sure exactly what they mean by claiming it as exempt, but may be sufficient to have stated that on the Statement of Intention form.