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..