Investment gone bad....Client put $50K into a partnership and the partnership invested in a RE company that stole the money - how to report?

[Ephesians3-14]

My client invested $50,000 into a partnership with some other friends. The partnership invested the money in a real estate investment company. Turns out the real estate developer stole the funds and (this is true) was later murdered. 

Of course, those funds will never be recovered by the partnership. How would the loss that the partnership incurred be reported on the Form 1065?

Capital loss or Section 1231 loss? (I am preparing the Form 1065)

Seems like the K-1 should report the pass through loss rather than the partner just claiming a capital loss on Sched D of their personal return for their $50,000 original investment.. 

[TaxMonkey · Accepted solution]

I agree that partnership should report the loss of partnership funds.  The nature of the loss will be determined by the facts and circumstances of their investment.  Given your description I could see several possibilities, did the partnership actually own part of the RE company?  How many layers in this onion?

[Ephesians3-14]

No, he just gave it to the real estate developer himself. The partnership did not invest in another company. They simply gave it to another person who was supposed to buy some properties for them but he ran off with the money.