Canceled Debt

I have a client with a rental property that was sold in a short sale in 2007. There was canceled debt in the amount of $332,517. I believe I am able to reduce the basis of the property by $293,567 and have additional rental income to report of $38,950. These numbers were computed by applying the exclusion limits. My question is what do I do with the basis reduction? Do I have to recapture it upon sale as if it were depreciation? I've been told to recapture it as section 1250, but I've also been told recapture it as section 1231. Hoping to get this misery of a return out of here now. Hope someone can help. Thanks.