The quest starts after you surrender to the city guards and get thrown to the jail without your items. You're supposed to receive all your items back once you escape the prison but it appears that currently all quest items dissappear from the inventory entirely and you only receive the items you can normally drop or sell at anytime. Based on a savegame just prior the jail, I can confirm that at least these items are lost:

Curious Silver Mold
Meridia's Beacon
Rjorn's Drum
Shards Of Mehrunes' Razor
Unusual Gem

Chances are that same thing happens for every single quest item that you might have in your inventory. Not sure if there's any workarounds, other than killing the guards and avoiding prison time entirely.