<PAGE>   1
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-Q


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

             For the quarterly period ended        September 30, 1996
                                            ------------------------------------

                                       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   0-15693
                                    -----------


                        QUEST HEALTH CARE FUND VII, L.P.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


            Delaware                                        58-1697905
--------------------------------------------------------------------------------
(State or other jurisdiction of                          (I.R.S. Employer 
incorporation or organization)                           Identification No.)



          1117 Perimeter Center West  E-210      Atlanta, GA 30338
--------------------------------------------------------------------------------
           (Address of principal executive offices)    (Zip code)



Registrant's telephone number, including area code       (770) 671-1014
                                                   -----------------------------


             Formerly: Southmark/CRCA Health Care Fund VII, L.P.
--------------------------------------------------------------------------------


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, and (2) has been subject to such filing
requirements for the past 90 days.     Yes   X    No
                                           -----     -----

                             There are no exhibits


                               TOTAL OF 16 PAGES





                                       1
<PAGE>   2
                        QUEST HEALTH CARE FUND VII, L.P.
                                 BALANCE SHEETS

                         PART I. FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS

                                     ASSETS

<TABLE>
<CAPTION>
                                                                               Sept. 30,           December 31,
                                                                              -----------          ------------
                                                                                 1996                  1995
                                                                              -----------          ------------
<S>                                                                           <C>                  <C>
CURRENT ASSETS
   Cash and cash equivalents                                                  $ 1,352,903          $ 1,325,321
   Accounts receivable, net of allowance
      for doubtful accounts of $42,932 and
      $25,000 at September 30, 1996 and
      December 31, 1995, respectively                                             767,474              914,057
   Prepaid expenses                                                                15,794              168,975
                                                                              -----------          -----------

         Total current assets                                                   2,136,171            2,408,353
                                                                              -----------          -----------

PROPERTY AND EQUIPMENT, at cost
   Land                                                                           233,770              233,770
   Buildings and improvements                                                   2,388,741            2,380,901
   Equipment and furnishings                                                      768,896              755,289
                                                                              -----------          -----------
                                                                                3,391,407            3,369,960
   Less accumulated depreciation and amortization                               2,355,701            2,297,709
                                                                              -----------          -----------

         Net property and equipment                                             1,035,706            1,072,251
                                                                              -----------          -----------

TOTAL ASSETS                                                                  $ 3,171,877          $ 3,480,604
                                                                              ===========          ===========
</TABLE>




The financial information included herein has been prepared by management
without audit by independent public accountants.  See notes to financial
statements.





                                       2
<PAGE>   3
                        QUEST HEALTH CARE FUND VII, L.P.
                                 BALANCE SHEETS



                        LIABILITIES AND PARTNERS' EQUITY


<TABLE>
<CAPTION>
                                                                           Sept. 30,           December 31,
                                                                          -----------          ------------
                                                                              1996                 1995
                                                                          -----------          ------------
<S>                                                                       <C>                  <C>
CURRENT LIABILITIES
   Current maturities of long-term debt                                   $    13,497          $    14,754
   Trade accounts payable                                                     331,251              334,994
   Accrued compensation                                                       178,030              116,582
   Accrued insurance                                                            3,461              103,962
   Estimated third party settlements                                          151,822               26,695
   Estimated sales tax settlement (Note 4)                                    279,691              279,691
   Other                                                                       94,736               94,036
   Payable to Quest and affiliates                                             78,261               11,992
                                                                          -----------          -----------

         Total current liabilities                                          1,130,749              982,706



LONG-TERM DEBT, less current maturities                                             -                9,629
                                                                          -----------          -----------

         Total liabilities                                                  1,130,749              992,335
                                                                          -----------          -----------

PARTNERS' EQUITY
   Limited Partners                                                         2,183,006            2,625,675
   General Partner                                                           (141,878)            (137,406)
                                                                          -----------          -----------

        Total partners' equity                                              2,041,128            2,488,269
                                                                          -----------          -----------

TOTAL LIABILITIES AND PARTNERS' EQUITY                                    $ 3,171,877          $ 3,480,604
                                                                          ===========          ===========
</TABLE>





The financial information included herein has been prepared by management
without audit by independent public accountants.  See notes to financial
statements.





                                       3
<PAGE>   4
                        QUEST HEALTH CARE FUND VII, L.P.
                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                             For the                               For the
                                                        Three Months Ended                    Nine Months Ended
                                                            September 30,                        September 30,
                                                    ----------------------------        -----------------------------
                                                       1996              1995              1996              1995
                                                    ----------        ----------        -----------       -----------
<S>                                                 <C>               <C>               <C>               <C>
REVENUES:
   Operating revenue                                $1,587,092        $1,661,950        $ 5,109,659       $10,299,609
   Interest income                                       5,445            14,821             24,178            45,868
   Gain on sales                                             -                 -                  -           548,389
                                                    ----------        ----------        -----------       -----------
         Total revenues                              1,592,537         1,676,771          5,133,837        10,893,866
                                                    ----------        ----------        -----------       -----------

EXPENSES:
   Wages & salaries                                    797,683           752,173          2,437,269         4,743,015
   Payroll tax & employee benefits                     130,977            41,899            439,861           906,854
   Supplies                                            218,170           186,893            688,515         1,032,105
   Other operating expenses                            223,637           143,858            510,769         1,118,340
   Ancillary services                                  181,321           225,261            707,946         1,019,800
   Health benefits                                      32,160            25,905            106,650           173,760
   Management fees                                      83,507            83,141            261,415           535,925
   Management fees-affiliate                            16,702            16,628             52,425            97,490
   Property taxes                                       15,491            15,417             46,649            73,779
   Interest                                                440               800              1,855            27,280
   Depreciation and amortization                        18,091            20,780             57,992           153,764
   Partnership administration                          117,392            90,752            269,632           516,205
                                                    ----------        ----------        -----------       -----------

         Total expenses                              1,835,571         1,603,507          5,580,978        10,398,317
                                                    ----------        ----------        -----------       -----------



Net income(loss)                                    $ (243,034)       $   73,264        $  (447,141)      $   495,549
                                                    ==========        ==========        ===========       ===========

Net income per Limited
   Partnership Unit                                 $     (.86)       $      .26        $     (1.59)      $      1.76
                                                    ==========        ==========        ===========       ===========

Weighted average Limited Partnership
   Units outstanding                                   279,278           279,278            279,278           279,278
                                                    ==========        ==========        ===========       ===========
</TABLE>



The financial information included herein has been prepared by management
without audit by independent public accountants.  See notes to financial
statements.





                                       4
<PAGE>   5
                        QUEST HEALTH CARE FUND VII, L.P.
                         STATEMENTS OF PARTNERS' EQUITY





<TABLE>
<CAPTION>
                                                                                           Total
                                                  General             Limited             Partners'
                                                  Partner             Partners             Equity
                                                 ---------           ----------          ----------



<S>                                              <C>                 <C>                 <C>
Balance at December 31, 1994                     $(142,741)          $7,403,755          $7,261,014

Net income                                           4,955              490,594             495,549

Distributions                                           -            (5,306,282)         (5,306,282)
                                                 ---------           ----------          ----------

Balance at Sept. 30, 1995                        $(137,786)          $2,588,067          $2,450,281
                                                 =========           ==========          ==========


Balance at December 31, 1995                     $(137,406)          $2,625,675          $2,488,269

Net loss                                            (4,472)            (442,669)           (447,141)
                                                 ---------           ----------          ----------

Balance at Sept. 30, 1996                        $(141,878)          $2,183,006          $2,041,128
                                                 =========           ==========          ==========
</TABLE>





The financial information included herein has been prepared by management
without audit by independent public accountants.  See notes to financial
statements.





                                       5
<PAGE>   6
                        QUEST HEALTH CARE FUND VII, L.P.
                            STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                         Nine Months Ended
                                                                              Sept. 30,
                                                                   -------------------------------
                                                                      1996                1995
                                                                   -----------         -----------
<S>                                                                <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Cash received from residents and
      government agencies                                          $ 5,256,242         $10,730,186
   Cash paid to suppliers and
      employees                                                     (5,147,533)        (10,464,679)
   Interest received                                                    24,178              45,868
   Interest paid                                                        (1,855)            (27,280)
   Real estate taxes paid                                              (71,118)            (96,519)
                                                                   -----------         -----------

Net cash provided by operating activities                               59,914             187,576
                                                                   -----------         -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from sale of facilities                                          -           5,070,998
   Payment for purchases of property
      and equipment                                                    (21,447)            (34,845)
   Funding of restricted accounts                                            -              (4,495)
                                                                   -----------         -----------

Net cash provided by investing activities                              (21,447)          5,031,658
                                                                   -----------         -----------

CASH FLOWS FROM FINANCING ACTIVITIES:

   Distribution to partners                                                  -          (5,306,282)
   Principal payments on long-term debt                                (10,885)            (18,512)
                                                                   -----------         -----------

NET CASH USED IN FINANCING ACTIVITIES                                  (10,885)         (5,324,794)
                                                                   -----------         -----------

Increase (decrease) in cash and cash
   equivalents                                                          27,582            (105,560)
Cash and cash equivalents at beginning of
   period                                                            1,325,321           1,469,459
                                                                   -----------         -----------
Cash and cash equivalents at end of period                         $ 1,352,903         $ 1,363,899
                                                                   ===========         ===========
</TABLE>




The financial information included herein has been prepared by management
without audit by independent public accountants.  See notes to financial
statements.





                                       6
<PAGE>   7
                        QUEST HEALTH CARE FUND VII, L.P.
                            STATEMENTS OF CASH FLOWS




<TABLE>
<CAPTION>
                                                                          Nine Months Ended
                                                                               Sept. 30,
                                                                    ------------------------------
                                                                       1996                1995
                                                                    ----------          ----------
<S>                                                                 <C>                 <C>
RECONCILIATION OF NET INCOME TO NET CASH
   PROVIDED BY OPERATING ACTIVITIES:

   Net income (loss)                                                $ (447,141)         $  495,549

   Adjustments to reconcile net income
      (loss) to net cash provided by
         operating activities:

           Depreciation and amortization                                57,992             153,764
           Gain on sale of facilities                                        -            (548,389)
           Abandoned development costs                                       -              92,304

   Changes in assets and liabilities

           Accounts receivable                                         146,583             430,577

           Prepaid expenses and other
              current assets                                           153,181            (213,588)

           Accounts payable and accrued
              liabilities                                               83,030            (206,326)

           Payable to Quest and affiliates                              66,269             (16,315)
                                                                    ----------          ----------

Net cash provided by
   operating activities                                             $   59,914          $  187,576
                                                                    ==========          ==========
</TABLE>





The financial information included herein has been prepared by management
without audit by independent public accountants.  See notes to financial
statements.





                                       7
<PAGE>   8
                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

                              September 30, 1996


NOTE 1

During interim periods, Quest Health Care Fund VII, L.P. (the "Partnership")
follows the accounting policies set forth in its Annual Report on Form 10-K
filed with the Securities and Exchange Commission.  Users of financial
information provided for interim periods should refer to the annual financial
information and footnotes contained in the Annual Report on Form 10-K when
reviewing the interim financial results presented herein.

In the opinion of management, the accompanying unaudited interim financial
statements, prepared in accordance with the instructions for Form 10-Q, contain
all material adjustments, consisting only of normal recurring adjustments
necessary to present fairly the financial condition, results of operations,
changes in partners' equity and cash flows of the Partnership for the
respective interim periods presented.  The results of operations for such
interim periods are not necessarily indicative of results of operations for a
full year.

NOTE 2 CASH AND CASH EQUIVALENTS

For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, demand deposits, money market funds and investments in certificates of
deposit with original maturities when purchased of three months or less.

The Partnership maintains cash accounts with a variety of unrelated banks, all
of which are covered by the Federal Deposit Insurance Corporation (FDIC).  At
September 30, 1996, the Partnership maintained cash balances at these banks
aggregating $940,990 in excess of the $100,000 FDIC insured maximum.

NOTE 3 TRANSACTIONS WITH AFFILIATES

The Partnership Agreement provides for payment of property management fees
based on 6% of gross property operating revenue. An affiliate of Quest receives
1% of gross property operating revenue relating to services provided directly
to the facilities.  Total payments under these contracts for the nine month
periods ending September 30, 1996 and 1995 were $52,425 and $97,490,
respectively.

Quest, in an effort to continue certain health benefits for employees, created
an employee benefit trust (the "Trust") in compliance with the guidelines
promulgated by VEBA and ERISA.  Quest has engaged a claims pre-certification
organization to review all claims made by the Partnership's employees.
Approximately $106,650 and $173,760 was recorded under this arrangement for the
nine month period ending September 30, 1996 and 1995, respectively. Amounts
contributed to the Trust by the Partnership and Partnership employees are
strictly for the benefit of employees of the participating employers, payment
of excess loss reinsurance, life insurance and accidental death and
dismemberment and claims and plan administration and employee medical claims.





                                       8
<PAGE>   9
                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS


NOTE 4  LITIGATION

In 1994, a complaint associated with a sexual harassment and wrongful
termination was filed against the Partnership.  The plaintiff is seeking an
unspecified amount of damages.  The Partnership's liability, if any, is not
determinable at this time and no provision has been made in the accompanying
Financial Statements.  It is the opinion of management that the ultimate
resolution will not have a material effect on the Partnership's financial
position. There has been no significant change in the status of this litigation.

In December 1994, the Partnership received a Notice and Demand for Payment from
the Idaho State Tax Commission resulting from sales tax audits for the years
1976 through 1988 under a theory of successor liability for approximately
$470,000.  Management of the Partnership is discussing a settlement of this
matter and has recorded a provision in the Financial Statements for $352,602,
at December 31, 1994.  As a result of selling certain facility interests in
1995, this successor liability was reduced to $373,000 and reserves reduced to
$279,691.  Management is of the opinion that the final resolution will not have
a material adverse effect on the Partnership's financial position.  To date,
the State of Idaho has not responded to the Partnership.  No other legal
actions, other than ordinary routine litigation incidental to business, were
filed against the Partnership during the nine month period.

NOTE 5 SALE OF FACILITIES

In February 1995, the Partnership sold its partnership interest in one facility
to an unaffiliated third party and recognized a gain of $200,446.  The
Partnership was relieved of the mortgage obligations secured by the facility of
$1,830,000, received cash of $1,700,000 and was relieved of any obligations
relating to Medicaid or Medicare settlements, audit adjustments and prior
reimbursement recapture by Medicare.

In addition, the Partnership sold its interests in four of its facilities in
1995 to a different unaffiliated third party.  The Partnership reflected an
estimated loss on the sale of these facilities of $4,898,869 at December 31,
1994 and recognized a gain of $347,943 upon closing of the sale on April 30,
1995.  The contract provided for adjusting working capital, as defined, to
exclude interpartnership accounts and the current portion of long term debt and
to reflect a 25% discount on accounts receivable at closing for the sale of the
Partnership's interests in the four facilities.  The contract also provided for
cash consideration adjustments based on changes in working capital including
the change in the 25% discount proportionate to changes in accounts receivable
occurring between December 31, 1994 and the date of closing.  The Partnership
made a final determination of adjusted working capital when the Partnership's
accountants completed certain agreed upon procedures.  Total cash received by
the Partnership was $3,370,998, and the purchaser assumed debt related to
equipment





                                       9
<PAGE>   10
                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS


NOTE 5 SALE OF FACILITIES continued

of approximately $63,000. Distributions of $2,792,780 or $10/unit were made to
the limited partners in March 1995 and $2,513,502 or $9/unit were made in June
1995.

The balance sheet of the Partnership reflects the effects of the sale of the
Partnership's interests in the five facilities and the write down of book
values. (see Note 8)  The Partnership is seeking to liquidate the Partnership's
interests in its three remaining facilities. Subsequent to the end of the third
quarter, the Partnership reached an agreement in principal to sell the Valley
Convalescent facility to an unaffiliated third party.


NOTE 6 PRO FORMA INFORMATION (UNAUDITED)

Due to the impact of the Partnership selling its interests in five of its
facilities during 1995, historical results of operations may not be indicative
of future  results of operations and net income (loss) per limited partnership
unit.  The following unaudited pro forma condensed statement of operations is
presented as if the transactions previously described occurred as of January 1,
1995.

The pro forma condensed financial information does not purport to present what
actual results of operations would have been if the transactions previously
described had occurred on such dates or to project results for any future
period.  It is management of the Partnership's belief that all adjustments
necessary to reflect the effects of the sales have been made.





                                       10
<PAGE>   11
                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

NOTE 6 PRO FORMA INFORMATION (UNAUDITED) continued

                PRO FORMA CONDENSED STATEMENT OF OPERATIONS (B)
                  For the Nine Months Ended September 30, 1995
                            (Unaudited in thousands)

<TABLE>
<CAPTION>
                                 Historical     Adjustments       Pro Forma
<S>                               <C>           <C>                <C>
Revenues:                         $ 10,345      $ (5,301) (A)      $ 5,044
                                  --------      --------           -------

Expenses:
 Wages and salaries               $  4,743      $ (2,537) (A)      $ 2,206
 Operating expenses                  4,251        (2,140) (A)        2,111
 Management fees                       536          (287) (A)          249
 Management fees-affiliate              97           (49) (A)           48
 Property taxes and interest           101           (52) (A)           49
 Depreciation and amortization         154           (92) (A)           62
 Partnership administration            516             -               516
                                  --------      --------           -------
                                    10,398        (5,157)            5,241
                                  --------      --------           -------

Net income (loss) (B)             $    (53)     $   (144)          $  (197)
                                  ========      ========           =======
</TABLE>


(A)      The pro forma adjustments remove the revenues and expenses directly
         related to the five nursing homes sold.

(B)      The historical statement of operations for the period ended September
         30, 1995 includes a gain of $548, in thousands, from the sale of five
         facilities.  This amount is not included in the above pro forma
         condensed statement of operations due to the non-recurring nature.

NOTE 7 GOING CONCERN

The Partnership's financial statements have been presented on the basis that it
is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business.  The sale of the
Partnership's interests in five nursing homes and possible future sales of any
or all of its remaining facilities will have an effect on cash flow from
operations in the future.

Management of the Partnership believes that successful control of facility and
Partnership expenses and establishing adequate reserves from the sales of
facilities should enable the Partnership to meet its obligations and upon the
final sale of its assets, liquidate in an orderly fashion.

NOTE 8 ACCOUNTING POLICIES

In March 1995, the Financial Accounting Standards Board issued Statement of
Accounting Standard No. 121 - "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of", which is effective for
fiscal years beginning after December 15, 1995.  Since the Partnership has
already recognized impairment losses effectively adjusting the carrying value
of its long-lived assets, as of December 31, 1994, to estimated net realizable
value, no significant adjustment from net realizable value to fair value is
expected.

During 1995, the Company adopted Statement of Financial Accounting Standards
No. 107, "Disclosures about Fair Value of Financial Instruments," which
requires disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet.  The carrying value of cash and
cash equivalents, accounts receivable, accounts payable and accrued expenses
approximate fair value due to the short-term nature of these instruments.
There are no off-balance sheet financial instruments to which the Partnership
is subject.





                                       11
<PAGE>   12
                                     PART I

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS:


Revenues:

Revenues for the nine months ended September 30, 1996 decreased $5,189,950 when
compared to the same period in 1995.  On a pro forma basis, removing the effect
of the sold facilities, revenues increased $108,068 over the comparable period
in 1995 and for the three month period decreased $74,858. This is the result of
$125,000 in prior year cost report adjustments for all facilities during the
third quarter, reflecting amounts due to Medicare for prior years, as well as
the future expected changes in Medicare allowable reimbursement levels. In
addition, during the third quarter, the Valley Convalescent facility
experienced lower occupancies as a result of a bed hold precipitated by an
unfavorable state survey. Subsequent to the end of the third quarter, the
facility was cleared of all deficiency claims of the state and occupancy is
returning to the levels experienced prior to the survey.

All resident receivables are recorded at their original face amount and are due
and payable under "normal" market terms and conditions.  In the event of
non-collection, the ultimate loss to the Partnership would be limited to the
recorded balance of the receivables as shown in the balance sheet.

The significant components of accounts receivable at September 30, 1996 and
December 31, 1995 are:

<TABLE>
<CAPTION>
                               1996             1995
                               ----             ----
<S>                            <C>              <C>
Medicaid                        70%              47%
Private Pay                     15%              10%
VA, Medicare and Other          15%              43%           
                               ---              ---
                               100%             100%
                               ===              ===
</TABLE>

Payments by both the state and federal governments are normally received within
60-90 days.  The sources of patient revenues for the nine months ended
September 30, 1996 and 1995 are:

<TABLE>
<CAPTION>
                               1996             1995
                               ----             ----
<S>                            <C>              <C>
Medicaid                        48%              60%
Private Pay                     10%              13%
VA, Medicare and Other          42%              27%
                               ---              ---
                               100%             100%
                               ===              ===
</TABLE>

Receivables decreased $146,583 during the nine months ended September 30, 1996
as compared to year end 1995.


Expenses:

Expenses for the nine months ended September 30, 1996 decreased $4,817,340 when
compared to the same period of 1995.  On a pro forma basis, eliminating the
effect of the sold facilities, expenses at the facilities increased $340,000.
$75,000 of this difference is attributable to a workers compensation insurance
dividend applied as an expense reduction in 1995. The expected dividend for
1996 was booked subsequent to the end of the third quarter 1996. This
difference is referenced in the employee benefits line item of the
Partnership's financial statements. In addition, salary increases were driven
by market forces and as a result of the publication of final rules relating to
OBRA 1987, staffing levels were increased. The new Federal Minimum Wage laws
are not expected to materially effect the Partnership as most employees earn
more than the newly established minimum wage. Furthermore, other operating
expense and supplies increased as result of additional accounting procedures
incurred in 1996 pertaining to the





                                       12
<PAGE>   13

facility sales in 1995, and the recognition of expense that had been fully
reimbursed by Medicare, but has recently been declared non-reimbursable and
included in the routine cost limitation set forth by HCFA.

Partnership administration costs were $269,632 and $516,205 for the nine month
periods ending September 30, 1996 and 1995, respectively.  Such charges
represent legal costs associated with litigation and SEC filings, investor
service functions and other partnership administration costs.  In 1995,
significant legal and accounting expenses were incurred in conjunction with the
sale of the Partnership's interests in certain facilities. During the latter
part of 1996, legal expenses can be expected to increase as a result of
negotiating contracts for sale of the Partnership's interests in facilities

Valley Convalescent located in California has achieved increased revenues
during the nine months ended September 30, 1996 despite the problems associated
with the new stringent survey procedures instituted during 1996 by HCFA, and
despite the fact that the State of California did not increase reimbursement in
1996, for the third year in a row. As mentioned above, a worker's compensation
insurance dividend of $75,000 was recognized as an expense reduction in third
quarter 1995 in addition to a $48,000 workers compensation dividend reflected
in the first quarter of 1995. No similar expense reductions were recognized
during the same periods in 1996. Furthermore, as a result of a prior year cost
report, changes in Medicare reimbursement policy, and as required by accounting
policy, $120,000 was accrued as due to Medicare during the third quarter 1996.
Given these factors, the facility can expect to experience a continued decline
in operating margins throughout 1996, as compared to 1995.  This facility's
dependence on Medicare increases the sensitivity of the facility to changes
instituted by Congress and by HCFA.  Rate freezes, block grants and reduced
funding all suggest caution in the Partnership's expectations for this facility
as well as the others.  Despite market uncertainties, every effort will be made
by management of the Partnership to maximize facility values for sale (See
"Liquidity and Capital Resources" below regarding a pending contract for sale
of the Valley Convalescent facility).  Valley Living, in Idaho, has improved
census and controlled expenses and currently generates positive cash flow.
Mountain View continues to suffer the consequence of the new facility in town.
To protect the interests of the Partnership, the Mountain View facility must
continue operations pending a resolution of the sales tax claims and the
employee complaint.  (See Item I, Note 4)

The explosive nationwide growth in Ancillary expenditures funded through the
Medicare system has raised the level of scrutiny of the expense areas by HCFA.
The Partnership believes it has complied with he regulation of ancillary
expense.  However, should HCFA substantially revise the ancillary programs or
reimbursement allowances, the Partnership's revenues could be substantially
impacted as well. The actual effect can not be determined until HCFA or
Congress makes more specific knowledge available.

Liquidity and Capital Resources:

This Quarterly Report on Form 10-Q contains certain forward-looking statements
that involve substantial known and unknown risks and uncertainties. When used
in this Form 10-Q, the terms "anticipates," "expects," "estimates," "believes"
and similar such terms as they relate to the Partnership or its management are
intended to identify such forward-looking statements. The Partnership's actual
results, performance or achievements may differ materially from those expressed
or implied by such forward-looking statements. Factors that could cause or
contribute to those differences include those discussed below. In evaluating
the Partnership's operations, readers should carefully consider the following
factors in addition to the other information presented in this Form 10-Q.

At September 30, 1996, the Partnership held cash and cash equivalents of
$1,352,903. This is an increase of $27,582 since December 31, 1995. There are
no major capital improvements planned at the remaining facilities.

In February 1995, the Partnership sold its partnership interest in one facility





                                       13
<PAGE>   14

to an unaffiliated third party and recognized a gain of $200,446.  The
Partnership was relieved of the mortgage obligations secured by the facility of
$1,830,000, received cash of $1,700,000 and was relieved of any obligations
relating to Medicaid or Medicare settlements, audit adjustments and prior
reimbursement recapture by Medicare.

In addition, the Partnership sold its interests in four of its facilities in
1995 to a different unaffiliated third party.  The Partnership reflected an
estimated loss on the sale of these facilities of $4,898,869 at December 31,
1994 and recognized a gain of $347,943 upon closing of the sale on April 30,
1995.  The contract provided for adjusting working capital, as defined, to
exclude interpartnership accounts and the current portion of long-term debt and
to reflect a 25% discount on accounts receivable at closing for the sale of the
Partnership's interests in the four facilities.  The contract also provided for
cash consideration adjustments based on changes in working capital including
the change in the 25% discount proportionate to changes in accounts receivable
occurring between December 31, 1994 and the date of closing.  The Partnership
made a final determination of adjusted working capital when the Partnership's
accountants completed certain agreed upon procedures.  Total cash received by
the Partnership was $3,370,998, and the purchaser assumed debt related to
equipment of approximately $63,000.

Neither the General Partner nor its affiliates received any remuneration or
distributions of these sales proceeds.

The balance sheet of the Partnership reflects the effects of the sale of the
Partnership's interests in the five facilities. In addition, the book balance
of each facility was adjusted, at year end 1994, based upon the knowledge and
circumstances existing at that time and in keeping with the Statement of
Accounting Standard No. 121 ("SAS 121")(see below). The Partnership is seeking
to liquidate the Partnership's interests in its three remaining facilities.
Distributions of $2,792,780 or $10/unit were made to the limited partners in
March 1995 and $2,513,502 or $9/unit were made in June 1995. An agreement in
principal has been reached to sell the Partnership's interest in Valley
Convalescent.  The final price, which is payable entirely in cash, includes
changes in working capital during the closing process.  However, since SAS 121
required writing down the value of the facility, the partnership's books
reflect Valley Convalescent at a value of $757,636 as of year end 1995. The
agreed to offer on the facility should recover substantially more than this
value. Therefore, the partnership equity shown on the September 30, 1996
balance sheet of $2,041,128, or $7.31 per partnership unit, does not reflect
the current market value of Partnership, but does comply with the accounting
policy more fully described in the Partnership's Annual Report on Form 10-K,
for the year ended December 31, 1995. Should this all cash offer be
consummated, management of the Partnership believes that the limited partners
could receive distributions approximating $12 per unit upon final liquidation.
This statement is entirely dependent upon the Partnership's facilities, or the
Partnership itself, not experiencing any adverse change in condition such as
changes in state or federal reimbursement policy or new mandates causing
unreimbursed expenses, unexpected loss of a facility, insured or not, or as the
result of any litigation effecting the Partnership causing an unexpected
consumption of the Partnership's working capital.

In February 1995, the limited partners of the Partnership received hostile
tender offer materials offering to purchase the units of certain limited
partners of the Partnership.  After a thorough analysis of the tender offer
materials, the General Partner recommended that the limited partners vote
against the tender offer, as such tender offer was not in the best interests of
the limited partners of the Partnership.  The unfriendly bidder amended its
tender offer materials three times requiring the Partnership to respond to the
offer at a cost to the Partnership.  The expense of the printed materials and
legal advice necessary to represent the Partnership's belief exceeded $160,000.

The Partnership has received certain expressions of interest in acquiring two of





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<PAGE>   15

the Partnership's three remaining facility interests. An offer to purchase
Valley Convalescent has been accepted by the Partnership, however, no offers
have yet been made for the two other facilities.

Medicare is a federal entitlement program and Medicaid (the source of the
majority of the Partnership's revenues) represents an entitlement program
administered differently by each state which is partially funded by the Federal
government.  In August 1993, Congress enacted Title XIII of OBRA 93.  This act,
among other things taxed social security benefits received by the elderly and
further limited payments under state Medicaid programs for which federal
matching would be permitted.  In October 1993, HCFA implemented a freeze on
Medicare reimbursement on routine cost limits, certain Part B ancillaries and
prospective payment system rates.  In addition, HCFA eliminated the return on
equity component of the reimbursement rate.  Further, by the end of 1993,
several states, because of federal actions and/or budgetary difficulties, had
either taken action to curtail the growth in entitlement programs and/or had
indicated that future action was possible.  Despite the fact that health care
reform proposals at the federal level have been significantly reduced,
activities at the state level continue and are encouraged by HCFA.  The latest
idea continues to be "block grants" to the states.  What this means to nursing
facilities cannot currently be determined by management of the Partnership.

The Partnership has no established credit lines with outside lending sources
and relies solely on cash flow and cash resources to conduct Partnership
business.  There are no material commitments for capital improvements at the
remaining facilities.

The Partnership's continued existence is dependent upon its ability to: (i)
generate sufficient cash flow to meet its obligations on a timely basis; and
(ii) obtain additional sources of funding as may be required.  As stated above,
the Partnership will entertain offers to sell any or all of its three remaining
facilities and, if accepted and closed, plans to liquidate in an orderly 
fashion.

In March 1995, the Financial Accounting Standards Board issued Statement of
Accounting Standard No. 121 - "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of", which became effective for
fiscal years beginning after December 15, 1995.  Since the Partnership has
recognized impairment losses and the losses were discussed in the 1993 and 1994
Annual Reports on Form 10-K, effectively adjusting the carrying value of its
long-lived assets to estimated net realizable value, no significant adjustment
from net realizable value to fair value is expected.

Effective as of September 30, 1996, Michael G. Hunter, president and a director
of the general partner of the general partner of the Partnership, resigned his
positions with such entity to pursue other business interests and is no longer
involved in the management of the Partnership.


                          PART II.  OTHER INFORMATION

ITEMS 1-5

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(A) Exhibits.

Exhibit 27 - Financial Data Schedule (for SEC use only)

(B) Reports on Form 8-K.

None during the third quarter of 1996.





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<PAGE>   16
                                   SIGNATURES




Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.


                                        QUEST HEALTH CARE
                                        FUND VII, L.P.
                                        (Registrant)


                                        By:  QUEST RESCUE PARTNERS - 7, L.P.
                                             General Partner

                                        By:  QUEST RESCUE PARTNERS - 7 CORP.


Date: November 18, 1996                 By:/s/ Stuart C. Berry 
                                           -------------------------------------
                                        CEO/CFO





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