Why is it wrong to say "není to ..." here?
Nothing. But you are the very first to comment on it. No submissions were made on that before
As kacenka9 said, "Není to dobrý chléb." is perfectly acceptable answer and you shouldn't be worried.
In other exercises Duo uses for translate "this" = "toto/tohle". Why the sentence is translated as "TO není dobrý chléb" and does not accept "TOTO není dobrý chléb" ?