<PAGE>
 
                                   FORM 10-Q

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C.  20549

(Mark One)
[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

     For the quarterly period ended     March 31, 1999
                                    ----------------------------------------

                                       OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

     For the transition period from _____________________to_________________

                        Commission file number  0-20253

                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
             (Exact name of registrant as specified in its charter)

                      Wisconsin                               39-1660958
               (State or other jurisdiction of               (I.R.S.Employer
                incorporation or organization)              Identification No.)

            101 W. 11th St., Suite 1110, Kansas City, Missouri 64105
          (Address of principal executive offices, including zip code)

                                 (816) 421-7444
              (Registrant's telephone number, including area code)


     Securities registered pursuant to Section 12(b) of the Act:  None

     Securities registered pursuant to Section 12(g) of the Act:  Limited
      Partnership Interests
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes     X     No
                                         ----------   ----------
<PAGE>
 
                         PART I - FINANCIAL INFORMATION
                         Item 1.  Financial Statements

                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                                 BALANCE SHEETS

                      March 31, 1999 and December 31, 1998
                      ------------------------------------

                                     ASSETS


<TABLE>
<CAPTION>
                                                  (Unaudited)
                                                   March 31,     December 31,
                                                     1999            1998
                                                  -----------    -------------
INVESTMENT PROPERTIES:  (Note 3)
<S>                                               <C>            <C>
     Land                                         $1,553,680       $1,553,680
     Buildings and improvements                    2,249,959        2,249,959
     Accumulated depreciation                       (729,720)        (713,396)
                                                  ----------       ----------
         Net investment properties                 3,073,919        3,090,243
                                                  ----------       ----------
OTHER ASSETS:
     Cash and cash equivalents                       257,127          230,807
     Cash held in Indemnification Trust (Note 8)     309,577          306,386
     Rents and other receivables                      21,808           14,463
     Deferred rent receivable                         20,358           20,778
     Deferred fees                                    19,292           19,738
     Prepaid assets                                    2,375            3,393
                                                  ----------       ----------
         Total other assets                          630,537          595,565
                                                  ----------       ----------
 
         Total assets                             $3,704,456       $3,685,808
                                                  ==========       ==========
 
</TABLE>

        The accompanying notes are an integral part of these statements.

                                       2
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                       LIABILITIES AND PARTNERS' CAPITAL

                      March 31, 1999 and December 31, 1998
                      ------------------------------------



<TABLE>
<CAPTION>
                                                    (Unaudited)
                                                     March 31,     December 31,
                                                       1999              1998
                                                     ----------    ------------
LIABILITIES:
<S>                                                   <C>            <C> 
     Accounts payable and accrued expenses            $21,249        $18,816
     Due to current General Partner                       246            229
     Security deposits                                 16,635         16,635
     Unearned rental income                            42,254         27,254
                                                      -------       --------
       Total liabilities                               80,384         62,934
                                                      -------       --------
CONTINGENET LIABILITIES:  (Note 7)
 
PARTNERS' CAPITAL:  (Notes 1, 4 and 9)
Current General Partner -
     Cumulative net income (loss)                      15,370         14,756
     Cumulative cash distributions                     (8,211)        (7,965)
                                                      -------       --------
 
                                                        7,159          6,791    
                                                      -------       --------
Limited Partners (17,102.52 interests outstanding)
   Capital contributions, net of offering costs    14,408,872     14,408,872
   Cumulative net loss                               (233,484)      (294,314)
   Cumulative cash distributions                  (10,292,984)   (10,232,984)
   Reallocation of former general partners' 
   deficit capital                                   (265,491)      (265,491)
                                                   ----------     ----------
                                                    3,616,913      3,616,083
                                                   ----------     ----------
          Total partners' capital                   3,624,072      3,622,874
                                                   ----------     ----------
          Total liabilities and partners' capital  $3,704,456     $3,685,808
                                                   ==========     ==========
</TABLE>


        The accompanying notes are an integral part of these statements.

                                       3
<PAGE>
 
                DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                             STATEMENTS OF INCOME

                                  (Unaudited)
                                  -----------

<TABLE>
<CAPTION>
                                                       Three Months Ended March 31,
                                                       ----------------------------
                                                           1999           1998
                                                       -------------  -------------
<S>                                                    <C>            <C>
REVENUES:
     Rental income                                          $109,367       $104,019
     Interest income                                           5,036         16,369
     Other income                                                  0             42
     Gain on sale of assets                                        0        238,698
     Recovery of amounts previously written off                2,683              0
                                                            --------       --------

                                                             117,086        359,128
                                                            --------       --------
EXPENSES:
     Partnership management fees                              16,301         16,045
     Disposition fees                                              0         37,500
     Restoration fees                                            107              0
     Insurance                                                 1,018          1,095
     General and administrative                                8,233         12,115
     Advisory Board fees and expenses                          1,400          4,358
     Professional services                                    11,813         22,589
     Professional services related to investigation                0            479
     Appraisal fees                                                0         13,900
     Depreciation                                             16,324         22,329
     Amortization                                                446            446
                                                            --------       --------
                                                              55,642        130,856
                                                            --------       --------
NET INCOME                                                  $ 61,444       $228,272
                                                            --------       ========
NET INCOME - GENERAL PARTNER                                $    614       $  2,283
NET INCOME - LIMITED PARTNERS                                 60,830        225,989
                                                            --------       --------
                                                            $ 61,444       $228,272
                                                            --------       ========
NET INCOME PER LIMITED PARTNERSHIP
 INTEREST, based on 17,102.52 interests outstanding            $3.56         $13.21
                                                            ========       ========
</TABLE>



       The accompanying notes are an integral part of these statements.



                                       4
<PAGE>
 
                DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
                ==============================================

                           STATEMENTS OF CASH FLOWS
                           ========================

                                  (Unaudited)
                                  -----------


<TABLE>
<CAPTION>
                                                                               Three Months Ended March 31,
                                                                               ----------------------------
                                                                                   1999             1998
                                                                               -----------      -----------
<S>                                                                           <C>               <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
     Net income                                                                   $ 61,444       $  228,272
     Adjustments to reconcile net income to net cash from (used in)
        operating activities -
          Depreciation and amortization                                             16,770           22,775
          Gain on sale of assets                                                         0         (238,698)
          Recovery of amounts previously written off                                (2,683)               0
          Interest applied to Indemnification Trust Account                         (3,191)          (4,503)
          (Increase)/Decrease in rents, other receivables & prepaid assets          (6,327)           9,908
          Decrease in deferred rent receivable                                         420            8,992
          Increase in accounts payable and accrued expenses                          2,433            3,216
          Increase/(Decrease) in due to General Partner                                 17             (482)
          Increase in unearned rental income                                        15,000              274
          (Decrease) in security deposits                                                0          (20,184)
                                                                                  --------       ----------
               Net cash provided from operating activities
                                                                                    83,883            9,570
                                                                                  --------       ----------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
     Recoveries from former affiliates                                               2,683                0
     Proceeds from sale of assets                                                        0        1,242,562
                                                                                  --------       ----------

               Net cash provided from investing activities                           2,683        1,242,562
                                                                                  --------       ----------
                                                                                  
CASH FLOWS (USED IN) FINANCING ACTIVITIES:
     Cash distributions to General Partner                                            (246)            (913)
     Cash distributions to Limited Partners                                        (60,000)        (385,000)
                                                                                  --------       ----------
               Net cash (used in) financing activities
                                                                                   (60,246)        (385,913)
                                                                                  --------       ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS                                           26,320          866,219

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                   230,807          595,420
                                                                                  --------       ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                                        $257,127       $1,461,639
                                                                                  ========       ==========
</TABLE>
 
 
 
       The accompanying notes are an integral part of these statements.
 

                                       5
<PAGE>
 
                DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                         NOTES TO FINANCIAL STATEMENTS


These unaudited interim financial statements should be read in conjunction with
DiVall Income Properties 3, Limited Partnership's (the "Partnership") 1998
annual audited financial statements within Form 10-K.

These unaudited financial statements include all adjustments which are, in the
opinion of management, necessary to present a fair statement of financial
position as of March 31, 1999, and the results of operations for the three-month
periods ended March 31, 1999, and 1998, and cash flows for the three-month
periods ended March 31, 1999 and 1998.  Results of operations for the periods
are not necessarily indicative of the results to be expected for the full year.


1.   ORGANIZATION AND BASIS OF ACCOUNTING:
     -------------------------------------

The Partnership was formed on December 12, 1989, pursuant to the Uniform Limited
Partnership Act of the State of Wisconsin.  The initial capital which was
contributed during 1989, consisted of $300, representing aggregate capital
contributions of $200 by the former general partners and $100 by the Initial
Limited Partner.

The Partnership initially offered two classes of Limited Partnership interests
for sale:  Distribution interests ("D-interests") and Retention interests ("R-
interests").  Each class was offered at a price (before volume discounts) of
$1,000 per interest.  The Partnership offered the two classes of interests
simultaneously up to an aggregate of 25,000 interests.

The minimum offering requirements for the D-interests were met and escrowed
subscription funds were released to the Partnership as of July 13, 1990.  The
offering closed on April 23, 1992, at which point 17,102.52 D-interests had been
issued, resulting in aggregate proceeds, net of discounts and offering costs, of
$14,408,872.

The minimum offering requirements for R-interests were not met.   During 1991,
680.9 R-interests were converted to D-interests and were reflected as
Partnership issuances in 1991.

The Partnership is currently engaged in the business of owning and operating its
investment portfolio (the "Properties") of commercial real estate. The
Properties are leased on a triple net basis to, and operated by, franchisors or
franchisees of national, regional and local retail chains under long-term
leases.  The lessees consist of fast-food, family style, and casual/theme
restaurants.  At March 31, 1999, the Partnership owned five (5) properties and
specialty leasehold improvements for use in all five (5) of the Properties.

Rental revenue from investment properties is recognized on the straight-line
basis over the life of the respective lease. Percentage rents are accrued
throughout the year based on the tenant's actual reported year-to-date sales
along with Management's estimate of the tenant's sales for any remaining
unreported periods during the year.


                                       6
<PAGE>
 
The Partnership considers its operations to be in only one segment and therefore
no segment disclosure is made.

Depreciation of the properties is provided on a straight-line basis over 31.5
years, which is the estimated useful lives of the buildings and improvements.

Deferred charges consist of leasing commissions paid when properties are leased
to tenants other than the original tenant.  Leasing commissions are capitalized
and amortized over the life of the lease.

Real estate taxes on the Partnership's investment properties are the
responsibility of the tenant.  However, when a tenant fails to make the required
tax payments or when a property becomes vacant, the Partnership makes the
appropriate payment to avoid possible foreclosure of the property.  Taxes are
accrued in the period for which the liability is incurred.

Cash and cash equivalents include cash on deposit in financial institutions and
highly liquid temporary investments with initial maturities of 90 days or less.

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities (and disclosure of
contingent assets and liabilities) at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

During 1996, the Partnership adopted Statement of Financial Accounting Standards
No.121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, which requires that all long-lived assets
be reviewed for impairment in value whenever changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.  The adoption of
SFAS 121 had no impact on the Partnership's financial statements.

The Partnership will be dissolved on December 1, 2015, or earlier upon the prior
occurrence of any of the following events:  (a)  the disposition of all
interests in real estate and other Partnership assets; (b) the decision by
Majority Vote (as defined in the Amended Agreement of Limited Partnership
("Partnership Agreement")) of the Limited Partners to dissolve the Partnership
or to compel the sale of all or substantially all of the Partnership's assets;
(c)  the failure to elect a successor General Partner within six months after
removal of the last remaining General Partner; or (d) the date of the death or
the effective date of dissolution, removal, withdrawal, bankruptcy, or
incompetency of the last remaining General Partner, unless the Partnership is
continued by vote of all Limited Partners and a replacement General Partner is
previously elected by a majority of the Limited Partners.  During the Second
Quarter of 1998, the General Partner received the consent of the Limited
Partners to liquidate the Partnership's assets and dissolve the Partnership.
Management is currently seeking a buyer for the Properties within the parameters
of the consent.  However, Management expects to continue normal operations for
the Partnership for the forseeable future.

No provision for Federal income taxes has been made, as any liability for such
taxes would be that of the individual partners rather than the Partnership.  At
December 31, 1998, the tax basis of the Partnership's assets exceeded the
amounts reported in the accompanying financial statements by approximately
$3,200,000.


                                       7
<PAGE>
 
2.   REGULATORY INVESTIGATION:

A preliminary investigation during 1992 by the Office of the Commissioner of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the "Investigation") revealed that during at least the three years ended
December 31, 1992, the former general partners of the Partnership, Gary J.
DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred substantial
cash assets of the Partnership and two affiliated publicly registered
partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall 1")
(dissolved effective December 31, 1998) and DiVall Insured Income Properties 2
Limited Partnership ("DiVall 2") (collectively the "Partnerships") to various
other entities previously sponsored by or otherwise affiliated with DiVall and
Magnuson. The unauthorized transfers were in violation of the respective
Partnership Agreements and resulted, in part, from material weaknesses in the
internal control system of the Partnerships.

Subsequent to discovery, and in response to the regulatory inquiries, a third-
party Permanent Manager, The Provo Group, Inc. ("TPG"), was appointed (effective
February 8, 1993) to assume responsibility for daily operations and assets of
the Partnerships as well as to develop and execute a plan of restoration for the
Partnerships. Effective May 26, 1993, the Limited Partners, by written consent
of a majority of interests, elected the Permanent Manager, TPG, as General
Partner. TPG terminated the former general partners by accepting their tendered
resignations.

In 1993, the current General Partner estimated an aggregate recovery of $3
million for the Partnerships. At that time, an allowance was established against
amounts due from former general partners and their affiliates reflecting the
estimated $3 million receivable. This net receivable was allocated among the
Partnerships based on each Partnership's pro rata share of the total
misappropriation. Through March 31, 1999, $5,768,000 of recoveries have been
received which exceeded the original estimate of $3 million. As a result, the
Partnership has recognized $1,286,000 as income over the past 3 years, which
represents its share of the excess recovery. The current General Partner
continues to pursue recoveries of the misappropriated funds, however no further
significant recoveries are anticipated.

3.   INVESTMENT PROPERTIES:

As of March 31, 1999, the Partnership owned five (5) fast-food restaurants
comprised of: two (2) Hardee's restaurants, one (1) Applebee's restaurant, and
two (2) Denny's restaurants. The five (5) properties are located in three (3)
states.

The total cost of the investment properties includes the original purchase price
plus acquisition fees and other capitalized costs paid to an affiliate of the
former general partners.

According to the Partnership Agreement, the former general partners were to
commit 82% of the original offering proceeds to the acquisition of investment
properties. Upon full investment of the net proceeds of the offering,
approximately 57% of the original offering proceeds was invested in the
Partnership's properties.

The current General Partner receives a fee for managing the Partnership equal to
4% of gross receipts, with a maximum reimbursement for office rent and related
overhead of $25,000 between the three original affiliated Partnerships as
provided in the Permanent Manager Agreement ("PMA"). On May 26, 1993, the
Permanent Manager, TPG, replaced the former general partners as the new General
Partner, as

                                       8
<PAGE>
 
provided for in an amendment to the Partnership Agreement dated May 26, 1993.
Pursuant to amendments to the Partnership Agreement, TPG continues to provide
management services for the same fee structure as provided in the PMA mentioned
above. Effective March 1, 1999, the minimum management fee and the maximum
reimbursement for office rent and overhead increased by 1.6% representing the
allowable annual Consumer Price Index adjustment per the PMA. For purposes of
computing the 4% overall fee, gross receipts includes amounts recovered in
connection with the misappropriation of assets by the former general partners
and their affiliates. TPG has received fees from the Partnership totaling
$88,004 to date on the amounts recovered, which has been offset against the 4%
minimum fee.

Several of the Partnership's property leases contain purchase option provisions
with stated purchase prices in excess of the original cost of the properties.
The current General Partner is unaware of any unfavorable purchase options in
relation to original cost.

4.   PARTNERSHIP AGREEMENT:

The Partnership Agreement, prior to an amendment effective May 26, 1993,
provided that, for financial reporting and income tax purposes, net profits or
losses from operations were allocated 90% to the Limited Partners and 10% to the
former general partners. The Partnership Agreement also provided that Net Cash
Receipts, as defined, would be distributed 90% to the Limited Partners and 10%
to the former general partners, except that distributions to the former general
partners in excess of 1% in any calendar year would be subordinated to
distributions to the Limited Partners in an amount equal to their Original
Property Distribution Preference, as defined.

Net proceeds, as defined, were to be distributed as follows: (a) 1% to the
General Partners and 99% to the Limited Partners, until distributions to the
Limited Partners equal their Original Capital, as defined, plus their Original
Property Liquidation Preference, as defined, and (b) the remainder 90% to the
Limited Partners and 10% to the General Partners. Such distributions were to be
made as soon as practicable following the sale, financing or refinancing of an
original property.

On May 26, 1993, pursuant to the results of a solicitation of written consents
from the Limited Partners, the Partnership Agreement was amended to replace the
former general partners and amend various sections of the agreement. The former
general partners were replaced as General Partner, by The Provo Group, Inc., an
Illinois corporation. Under the terms of the amendment, net profits or losses
from operations are allocated 99% to the Limited Partners and 1% to the current
General Partner. The amendment also provided for distributions from Net Cash
Receipts to be made 99% to the Limited Partners and 1% to its current General
Partner. Pursuant to the amendments to the Partnership Agreement effective June
30, 1994, distributions of Net Cash Receipts will not be made to the General
Partner unless and until each Limited Partner has received a distribution from
Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return
on his or her Adjusted Original Capital, as defined, from the Return Calculation
Date, as defined, except to the extent needed by the General Partner to pay its
federal and state incomes taxes on the income allocated to it attributable to
such year. Distributions paid to the General Partner are based on the estimated
tax liability as a result of allocated income. Subsequent to the filing of the
General Partner's income tax returns, a true-up of actual distributions is made.
Net proceeds, as defined, was also amended to be distributed 1% to the current
General Partner and 99% to the Limited Partners.

Additionally, as per the amendment of the Partnership Agreement dated May 26,
1993, the total compensation paid to all persons for the sale of the investment
properties shall be limited to a competitive

                                       9
<PAGE>
 
real estate commission, not to exceed 6% of the contract price for the sale of
the property. The General Partner may receive up to one-half of the competitive
real estate commission, not to exceed 3%, provided that the General Partner
provides a substantial amount of services in the sales effort. It is further
provided that a portion of the amount of such fees payable to the General
Partner is subordinated to its success at recovering the funds misappropriated
by the former general partners. (See Note 7.)

Effective June 1, 1993, the Partnership Agreement was amended to (i) change the
definition of "Distribution Quarter" to be consistent with calendar quarters,
and (ii) change the distribution provisions to subordinate the General Partner's
share of distributions from Net Cash Receipts and Net Proceeds, except to the
extent necessary for the General Partner to pay its federal and state income
taxes on Partnership income allocated to the General Partner. Because these
amendments do not adversely affect the rights of the Limited Partners, pursuant
to section 10.2 of the Partnership Agreement, the amendments were made by the
General Partner without a vote of the Limited Partners.

5.   LEASES:

Lease terms for the investment properties are 20 years from their inception. The
leases provide for minimum rents and additional rents based upon percentages of
gross sales in excess of specified breakpoints. The lessee is responsible for
occupancy costs such as maintenance, insurance, real estate taxes, and
utilities. Accordingly, these amounts are not reflected in the statements of
income, except in circumstances where, in management's opinion, the Partnership
will be required to pay such costs to preserve assets (i.e., payment of past-due
real estate taxes). Management has determined that the leases are properly
classified as operating leases; therefore, rental income is reported when earned
and the cost of the property, excluding the cost of the land, is depreciated
over its estimated useful life.

Aggregate minimum lease payments to be received under the leases for the
Partnership's properties are as follows:
          <TABLE>
          <CAPTION>
          Year ending
          December 31,
          <S>                                               <C>
                 1999                                       $  409,380
                 2000                                          409,380
                 2001                                          409,380
                 2002                                          409,380
                 2003                                          409,380
         Thereafter                                          2,731,958
                                                            ----------
                                                            $4,778,858
                                                            ==========
          </TABLE>

Two (2) of the Partnership's properties are leased to a Denny's franchisee. Base
rent from these properties amounted to approximately 27% of total base rent in
1998.

Two (2) of the Partnership's properties are leased to Hardee's Food Systems,
Inc. Base rent from these properties amounted to approximately 43% of total base
rents.

                                      10
<PAGE>
 
The original offering document required the Partnership to lease its properties
to a single tenant as long as the properties so leased do not constitute; in the
aggregate, more than 20% of the aggregate gross proceeds of the offering. As of
March 31, 1999, the Partnership has leased two of its properties to Hardees Food
Systems, Inc., which constitute 21% of the aggregate gross proceeds.

6.   TRANSACTIONS WITH CURRENT GENERAL PARTNER:

Amounts paid to the current General Partner for the quarters ended March 31,
1999 and 1998, are as follow:

<TABLE>
<CAPTION>
     Current General Partner                Incurred as of   Incurred as of
     -----------------------                March 31, 1999   March 31, 1998
                                            --------------   --------------
<S>                                         <C>              <C>
Management fees                                    $16,301          $16,045
Disposition fees                                         0           37,500
Restoration fees                                       107                0
Cash distribution                                      246              913
Overhead allowance                                   1,315            1,294
Reimbursement for out-of-pocket expenses               798            3,161
                                                   -------          -------
                                                   $18,767          $58,913
                                                   =======          =======
</TABLE>

7.   CONTINGENT LIABILITIES:

According to the Partnership Agreement, the current General Partner may receive
a disposition fee not to exceed 3% of the contract price of the sale of
investment properties. Fifty percent (50%) of all such disposition fees earned
by the current General Partner is to be escrowed until the aggregate amount of
recovery of the funds misappropriated from the Partnerships by the former
general partners is greater than $4,500,000. Upon reaching such recovery level,
full disposition fees will thereafter be payable and fifty percent (50%) of the
previously escrowed amounts will be paid to the current General Partner. At such
time as the recovery exceeds $6,000,000 in the aggregate, the remaining escrowed
disposition fees shall be paid to the current General Partner. If such levels of
recovery are not achieved, the current General Partner will contribute the
amounts escrowed towards the recovery. In lieu of an escrow, 50% of all such
disposition fees have been paid directly to the restoration account and then
distributed among the three Partnerships. After surpassing the $4,500,000
recovery level during March 1996, 50% of the amounts previously escrowed was
refunded to the current General Partner. The remaining amount allocated to the
Partnerships may be owed to the current General Partner if the $6,000,000
recovery level is met. As of March 31, 1999, the Partnership may owe the current
General Partner $18,862, which is currently reflected as a recovery, if the
$6,000,000 recovery level is achieved, which is unlikely.

8.   PMA INDEMNIFICATION TRUST:

The PMA provides that the Permanent Manager will be indemnified from any claims
or expenses arising out of or relating to the Permanent Manager serving in such
capacity or as substitute general partner, so long as such claims do not arise
from fraudulent or criminal misconduct by the Permanent Manager. The PMA
provides that the Partnership fund this indemnification obligation by
establishing a reserve of up to

                                      11
<PAGE>
 
$250,000 of Partnership assets which would not be subject to the claims of the
Partnership's creditors. An Indemnification Trust ("Trust") serving such
purposes has been established at United Missouri Bank, N.A. The Trust has been
fully funded with Partnership assets as of March 31, 1999. Funds are invested in
U.S. Treasury securities. In addition, interest totaling $59,577 has been
credited to the Trust as of March 31, 1999. The rights of the Permanent Manager
to the Trust shall be terminated upon the earliest to occur of the following
events: (i) the written release by the Permanent Manager of any and all interest
in the Trust; (ii) the expiration of the longest statute of limitations relating
to a potential claim which might be brought against the Permanent Manager and
which is subject to indemnification; or (iii) a determination by a court of
competent jurisdiction that the Permanent Manager shall have no liability to any
person with respect to a claim which is subject to indemnification under the
PMA. At such time as the indemnity provisions expire or the full indemnity is
paid, any funds remaining in the Trust will revert back to the general funds of
the Partnership.

9.   FORMER GENERAL PARTNERS' CAPITAL ACCOUNTS:

The capital account balance of the former general partners as of May 26, 1993,
the date of their removal as general partners pursuant to the results of a
solicitation of written consents from the Limited Partners, was a deficit of
$265,491. At December 31, 1993, the former general partners' deficit capital
account balance in the amount of $265,491 was reallocated to the Limited
Partners.

10.  SUBSEQUENT EVENTS:

On May 15, 1999, the Partnership made a distribution to the Limited Partners for
the First Quarter 1999 of $60,000 amounting to approximately $3.51 per limited
partnership interest.

Item 2.  Management's Discussion and Analysis of Financial Condition and Results
of Operations

Liquidity and Capital Resources:

Investment Properties and Net Investment in Direct Financing Leases

The investment properties, including equipment held by the Partnership at March
31, 1999, were originally purchased at a price, including acquisition costs, of
approximately $6,091,000.

Other Assets

Cash and cash equivalents were $257,000 at March 31, 1999, compared to $231,000
at December 31, 1998. The Partnership designated cash of $60,000 to fund the
First Quarter 1999 distributions to Limited Partners; $70,000 for the payment of
accounts payable and accrued expenses; and the remainder represents reserves
deemed necessary to allow the Partnership to operate normally. Cash generated
through the operations of the Partnership's investment properties and sales of
investment properties will provide the sources for future fund liquidity and
Limited Partner distributions.

The Partnership established an Indemnification Trust (the "Trust") during the
Fourth Quarter of 1993 and deposited $130,000 in the Trust during 1994, $100,000
during 1995, and $20,000 during 1996. The

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<PAGE>
 
provision to establish the Trust was included in the PMA for the indemnification
of TPG, in the absence of fraud or gross negligence, from any claims or
liabilities that may arise from TPG acting as Permanent Manager. The Trust is
owned by the Partnership. For additional information regarding the Trust, refer
to Note 8 to the financial statements.

Liabilities

Accounts payable and accrued expenses at March 31, 1999, in the amount of
$21,000, primarily represented the accrual of legal and auditing fees.

Partners' Capital

Net income for the quarter was allocated between the General Partner and the
Limited Partners, 1% and 99%, respectively, as provided in the Partnership
Agreement and the Amendment to the Partnership Agreement, as discussed more
fully in Note 4 of the financial statements. The former general partners'
capital account balance was reallocated to the Limited Partners at December 31,
1993. Refer to Note 9 to the financial statements for additional information
regarding the reallocation.

Cash distributions paid to the Limited Partners and to the General Partner
during 1999, of $60,000 and $246, respectively, have also been made in
accordance with the amended Partnership Agreement. The First Quarter 1999
distribution of $60,000 was paid to the Limited Partners on May 15, 1999.

Results of Operations:

The Partnership reported net income for the quarter ended March 31, 1999, in the
amount of $61,000 compared to net income for the quarter ended March 31, 1998 of
$228,000.

Revenues

Total revenues were $117,000, and $359,000, for the quarters ended March 31,
1999, and 1998, respectively. The 1998 income includes a gain of $239,000
recognized on the sale of a Denny's property to the tenant.

Total revenues, should approximate $400,000 annually or $100,000 quarterly,
based on leases currently in place. Future revenues may decrease with tenant
defaults and/or sales of Partnership properties. They may also increase with
additional rents due from tenants, if those tenants experience sales levels
which require the payment of additional rent to the Partnership.

Expenses

For the quarters ended March 31, 1999 and 1998, cash expenses amounted to
approximately 33% and 30% of total revenues, respectively. Total expenses,
including non-cash items, amounted to 48% and 36% of total revenues for the
quarters ended March 31, 1999 and 1998, respectively. During 1998, disposition
fees of $37,500 on the sale of the Denny's property in Sanford, Florida, and
fees incurred for the appraisal of the Partnership's properties totaling $13,900
had a negative impact on expenses. However, the gain recorded during 1998 had a
favorable impact on the expense to revenue ratios.

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<PAGE>
 
Inflation:

Inflation has a minimal effect on operating earnings and related cash flows from
a portfolio of triple net leases. By their nature, such leases actually fix
revenues and are not impacted by rising costs of maintenance, insurance, or real
estate taxes. If inflation causes operating margins to deteriorate for lessees
if expenses grow faster than revenues, then, inflation may well negatively
impact the portfolio through tenant defaults.

It would be misleading to associate inflation with asset appreciation for real
estate, in general, and the Partnership's portfolio, specifically. Due to the
"triple net" nature of the property leases, asset values generally move
inversely with interest rates.

Year 2000

The Partnership's operations are not dependent on date sensitive software. The
Partnership is not aware of any Year 2000 problems with its current software.
Accounting and Partnership records software are owned and operated by third
parties who provide services to the Partnership under contract and any cost to
make the software Year 2000 compliant will be borne by the third parties. The
Partnership is currently in the process of evaluating Year 2000 issues with
these third party providers. The Partnership believes, however, that even if any
Year 2000 problems are not corrected on schedule, the cost and disruption to
operations of the Partnership are expected to be minimal.

Tenants are responsible for the operation of any equipment located at the
Partnership's properties. While the Partnership is not fully aware of the
compliance attainment efforts of its tenants, tenant preparedness for the Year
2000 should have minimal impact on the Partnership and are not expected to be
material to the Partnership's operations, financial condition or liquidity. The
Partnership is evaluating the efforts of its tenants to prepare for the Year
2000. To the extent the Partnership is not satisfied with the status of a
tenant's or third party provider's Year 2000 compliance, the Partnership expects
to develop and implement appropriate contingency plans.

Item 3.   Quantitative and Qualitative Disclosure About Market Risk

None.

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<PAGE>
 
                          PART II - OTHER INFORMATION

Items 1 - 5.

Not Applicable.

Item 6.  Exhibits and Reports on Form 8-K

(a)  Listing of Exhibits:

     99.0   Correspondence to the Limited Partners dated May 15, 1999, regarding
            the First Quarter 1999 distribution.

(b)  Report on Form 8-K:

     The Registrant filed no reports on Form 8-K during the first quarter of
     fiscal year 1999.

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<PAGE>
 
                                  SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP


By:    The Provo Group, Inc., General Partner



By:    /s/ Bruce A. Provo
       --------------------------------------
       Bruce A. Provo, President


Date:  May 14, 1999


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.


By:    The Provo Group, Inc., General Partner


By:    /s/ Bruce A. Provo
       --------------------------------------
       Bruce A. Provo, President


Date:  May 14, 1999



By:    /s/ Kristin J. Atkinson
       --------------------------------------
       Kristin J. Atkinson
       Vice President - Finance and Administration


Date:  May 14, 1999

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