UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C.  20549
                                    FORM 10-K

    X        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                     FOR FISCAL YEAR ENDED: AUGUST 31, 1996
                                       OR
           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

                       For the transition period from to .

                         Commission File Number: 0-18249

               PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
             (Exact name of registrant as specified in its charter)

      Virginia                                         04-3042283
(State of organization)                            (I.R.S. Employer
                                                  Identification  No.)

1285 Avenue of the Americas, New York, New York                       10104
    (Address of principal executive office)                         (Zip Code)

Registrant's telephone number, including area code:             (212) 713-4264
                                                                --------------

           Securities registered pursuant to Section 12(b) of the Act:
                                                       Name of each exchange on
 Title of each class                                        which registered
        None                                                      None

Securities registered pursuant to Section 12(g) of the Act:

                     Shares of Common Stock, $.01 Par Value
                                (Title of class)

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not  contained  herein, and will not be contained,  to the
best of registrant's  knowledge, in definitive  proxy or information  statements
incorporated  by  reference  in Part III of this Form 10-K or any  amendment  to
this Form 10-K.   X

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 for 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 .

Shares  of common  stock  outstanding  as of August  31,  1996:  7,520,100.  The
aggregate  sales  price  of the  shares  sold  was $75,201,000.  This  does  not
reflect market value.  There is no current market for these shares.

                       DOCUMENTS INCORPORATED BY REFERENCE
          Documents                                   Form 10-K Reference
Prospectus of registrant dated                               Part IV
June 9, 1989, as supplemented

Current Report on Form 8-K                                   Part IV
of registrant dated July 29, 1996



<PAGE>


               PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
                                 1996 FORM 10-K

                                TABLE OF CONTENTS


Part   I                                                                 Page

Item  1       Business                                                   I-1

Item  2       Properties                                                 I-3

Item  3       Legal Proceedings                                          I-4

Item  4       Submission of Matters to a Vote of Security Holders        I-5


Part  II

Item  5       Market for the Registrant's Shares and Related
                 Stockholder Matters                                    II-1

Item  6       Selected Financial Data                                   II-1

Item  7       Management's Discussion and Analysis of Financial Condition
                 and Results of Operations                              II-2

Item  8       Financial Statements and Supplementary Data               II-8

Item  9       Changes in and Disagreements with Accountants on Accounting
                 and Financial Disclosure                               II-8


Part III

Item  10      Directors and Executive Officers of the Registrant       III-1

Item  11      Executive Compensation                                   III-3

Item  12      Security Ownership of Certain Beneficial Owners
                and Management                                         III-3

Item  13      Certain Relationships and Related Transactions           III-3


Part  IV

Item  14      Exhibits, Financial Statement Schedules and Reports on 
               Form 8-K                                                 IV-1

Signatures                                                              IV-2

Index to Exhibits                                                       IV-3

Financial Statements and Supplementary Data                      F-1 to F-19


<PAGE>

                                    PART I

Item 1.  Business

   PaineWebber  Independent  Living  Mortgage  Fund,  Inc. (the  "Company") is a
finite-life  corporation  organized  on March  6,  1989 in the  Commonwealth  of
Virginia for the purpose of making construction and participating mortgage loans
secured by rental housing  complexes for independent  senior  citizens  ("Senior
Housing Facilities").  On June 21, 1989, the Company commenced a public offering
of up to 10,000,000 shares of common stock pursuant to a Registration  Statement
filed on Form S-11 under the Securities Act of 1933 (Registration  Statement No.
33-27653). On July 21, 1989, the public offering terminated.  The Company issued
7,520,100 shares,  representing capital  contributions of $75,201,000,  of which
$201,000  represented  the sale of 20,100  shares to an  affiliate,  PaineWebber
Group,  Inc.  ("PaineWebber").  As of  November  1,  1996,  PaineWebber  and its
affiliates  held 165,344 shares of the Company's  common stock.  The Company has
elected to qualify and be taxed as a Real Estate Investment Trust ("REIT") under
the  Internal  Revenue  Code of  1986,  as  amended,  for each  taxable  year of
operations.  As a REIT,  the  Company is allowed a  deduction  for the amount of
dividends  paid  to  its  shareholders,   thereby  effectively   subjecting  the
distributed net income of the Company to taxation at the shareholder level only.
In order to qualify as a REIT,  the Company must  distribute at least 95% of its
taxable income on an annual basis and meet certain other requirements.

   The Company  originally  invested  the net  proceeds  of the  initial  public
offering  in eight  participating  mortgage  loans  secured  by  Senior  Housing
Facilities  located  in seven  different  states.  All of the loans  made by the
Company were originally with Angeles Housing Concepts,  Inc. ("AHC"),  a company
specializing  in the  development,  acquisition  and operation of Senior Housing
Facilities.  The Company entered into an Exclusivity  Agreement with AHC and its
parent company, Angeles Corporation  ("Angeles"),  which required AHC to provide
the Company  with  certain  specific  opportunities  to finance  Senior  Housing
Facilities  and set forth the terms and conditions of the loans which were made.
The loan documents under the  aforementioned  Exclusivity  Agreement  called for
interest to be paid on  construction  loans at the rate of 13% per annum  during
the construction  period and for Base Interest to be paid on the permanent loans
at the rate of 10% per  annum.  In  addition  to the Base  Interest,  Additional
Interest was to be payable on the  permanent  loans in an amount equal to 10% of
the Gross Revenues of the Senior Housing Facilities, as defined. Under the terms
of the amended Exclusivity Agreement, Additional Interest was to be no less than
3% of the aggregate  principal amount of all permanent loans outstanding for the
entire term of the investments.  In the aggregate, the properties securing loans
from the Company did not generate sufficient cash flow to cover the debt service
payments  owed  to the  Company  under  the  amended  terms  of the  Exclusivity
Agreement.  To the extent that the properties did not generate  sufficient  cash
flow to make the full payments due under the loan  documents,  the shortfall was
funded  by AHC  through  December  1992.  The  source  of cash to make up  these
shortfalls was from specified  deficit reserve  accounts,  which had been funded
from the proceeds of the mortgage loans, and from contributions by Angeles.

   During the quarter ended  February 28, 1993,  Angeles  announced  that it was
experiencing  liquidity  problems  that  resulted in the  inability  to meet its
obligations.  Subsequent to such  announcements,  AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment  properties.  On May 3,
1993,  Angeles filed for  reorganization  under a Chapter 11 Federal  Bankruptcy
petition filed in the state of California.  AHC did not file for reorganization.
The Company  retained  special counsel and held extensive  discussions  with AHC
concerning the default status of its loans.  During the fourth quarter of fiscal
1993, a non-binding  settlement  agreement between the Company,  AHC and Angeles
was reached whereby ownership of the properties would be transferred from AHC to
the  Company or its  designated  affiliates.  Under the terms of the  Settlement
Agreement,  the Company released AHC and Angeles from certain  obligations under
the loans. On April 27, 1994,  each of the properties  owned by AHC and securing
the Loans was  transferred  (collectively,  "the  Transfers")  to  newly-created
special purpose  corporations  affiliated with the Company  (collectively,  "the
Property  Companies").  The Transfers had an effective date of April 1, 1994 and
were made pursuant to the Settlement Agreement entered into on February 17, 1994
("the  Settlement  Agreement")  between the Company and AHC which had previously
been approved by the bankruptcy  court handling the bankruptcy  case of Angeles.
All of the capital stock of each Property Company was held by ILM Holding,  Inc.
("ILM Holding"),  a Virginia  corporation.  In August 1995, each of the Property
Companies merged into ILM Holding. As a result,  ownership of the Senior Housing
Facilities  is now held by ILM  Holding,  and the  Property  Companies no longer
exist as separate legal  entities.  The capital stock of ILM Holding is owned by
the Company and PWP Holding, Inc. ("PWP Holding"), a wholly-owned  subsidiary of
PaineWebber Properties  Incorporated ("PWPI"). PWPI is a wholly owned subsidiary
of PaineWebber  Incorporated,  which is a wholly owned subsidiary of PaineWebber
Group, Inc. ("PaineWebber"). The Company holds substantially all of the economic
ownership in ILM Holding, while PWP Holding holds voting control. As part of the
fiscal 1994  settlement  agreement  with AHC,  ILM Holding  retained  AHC as the
property manager for all of the Senior Housing Facilities  pursuant to the terms
of a  management  agreement.  As  discussed  further  in Item 7, the  management
agreement with AHC was terminated in July 1996.

   Subsequent  to the  effective  date of the  Settlement  Agreement  with  AHC,
management  investigated and evaluated the available options for structuring the
ownership of the  properties in order to maximize the  potential  returns to the
existing  shareholders  while maintaining the Company's  qualification as a REIT
under the Internal Revenue Code. To retain REIT status,  the Company must ensure
that 75% of its annual gross income is received from  qualified  sources.  Under
the original investment  structure,  interest income from the Company's mortgage
loans was a qualified source.  The properties that are now owned by an affiliate
of the Company are Senior  Housing  Facilities  that  provide  tenants with more
services, such as meals,  activities,  assisted living, etc., than are customary
for  ordinary  residential  apartment  properties.  As a result,  a  significant
portion of the rents paid by the tenants includes income for the increased level
of services received by them. Consequently, the rents paid by the tenants likely
would  not be  qualified  rents  for REIT  qualification  purposes  if  received
directly by the Company. Therefore, if the Company received such rents directly,
it could lose REIT status and be taxed as a regular corporation. After extensive
review, the Board of Directors determined that it would be in the best interests
of the  shareholders  for the Company to retain REIT status and master lease the
properties to a  shareholder-owned  operating  company.  As discussed further in
Item 7, on September 12, 1994 the Company formed a new  subsidiary,  ILM I Lease
Corporation,  for the purpose of operating the Senior  Housing  Facilities.  The
Senior  Housing  Facilities  were  leased to ILM I Lease  Corporation  effective
September 1, 1995 (see Item 7 for a description of the master lease agreement).

      The Company's investments as of August 31, 1996 are described below:

Property Name                                            Date of
and Location (1)                 Type of Property        Investment     Size
--------------------             ----------------------  ----------    ------

Independence  Village of         Senior Housing Facility   6/29/89    156 Units
Winston-Salem                                               
Winston-Salem, NC

Independence Village of East     Senior Housing Facility   6/29/89    159 Units
Lansing                                                   
East Lansing, MI

Independence Village of          Senior Housing Facility   12/18/89   163 Units
Raleigh                                                     
Raleigh, NC

Independence Village of          Senior Housing Facility   12/18/89   164 Units
Peoria                                                    
Peoria, IL

Crown Pointe Apartments         Senior Housing Facility    2/14/89    133 Units
Omaha, NE                                                  


Sedgwick Plaza Apartments       Senior Housing Facility    2/14/89    150 Units
Wichita, KS                                               


West Shores                     Senior Housing Facility    12/14/90   134 Units
Hot Springs, AR                                             


Villa Santa Barbara (2)         Senior Housing Facility    7/13/92    123 Units
Santa Barbara, CA                                           


(1) See Notes to the  Financial  Statements  filed with this Annual Report for a
    description of the  agreements  through which the Company has acquired these
    real estate investments.

(2) The acquisition  and  improvement of the Santa Barbara  facility was jointly
    financed by the Company and an affiliated company,  PaineWebber  Independent
    Living Mortgage Inc. II (ILM2).  Any amounts  generated by the operations of
    the Santa Barbara  property are equitably  apportioned  between the Company,
    together  with its  consolidated  affiliate,  and  ILM2,  together  with its
    consolidated affiliate (generally 25% and 75%, respectively).

   The Senior  Housing  Facilities  are  subject  to  competition  from  similar
properties  in the  vicinities  in which they are located.  The  properties  are
located in areas with significant  senior citizen  populations and, as a result,
there are, and will likely continue to be, a variety of competing projects aimed
at attracting  senior  residents.  Such projects will  generally  compete on the
basis of rental rates, services, amenities and location. The Company has no real
estate  investments  located  outside the United States.  The Company is engaged
solely in the business of real estate  investment.  Therefore,  presentation  of
information about industry segments is not applicable.

   The Company  originally  expected to liquidate its investments after a period
of  approximately  ten  years,  although  under the terms of its  organizational
documents  property  sales may occur at  earlier  or later  dates.  The Board of
Directors may defer the Company's scheduled  liquidation date, if in the opinion
of a majority of the Directors,  the disposition of the Company's assets at such
time would result in a material  under-realization  of the value of such assets;
provided,  however,  that no such deferral may extend beyond  December 31, 2004.
The net proceeds of any sale  transactions are expected to be distributed to the
Shareholders, so that the Company will, in effect, be self-liquidating.

   Subject to the supervision of the Company's Board of Directors, assistance in
the  management  of the business of the Company is provided by  PaineWebber  ILM
Advisor,  L.P.  (the  "Advisor"),  a limited  partnership  comprised of ILM REIT
Advisor,  Inc.,  a Virginia  corporation,  and  Properties  Associates,  L.P., a
Virginia  limited  partnership.  ILM  REIT  Advisor,  Inc.  is  a  wholly  owned
subsidiary  of PWPI.  The  partners  of the Advisor  are  affiliates  of PWI and
PaineWebber.

   There  are  currently  five  directors  of the  Company,  none  of whom is an
affiliate of the Advisor.  The  directors  are subject to removal by the vote of
the  holders  of a  majority  of  the  outstanding  shares.  The  directors  are
responsible for the general  policies of the Company,  but they are not required
to  personally  conduct  the  business  of the  Company in their  capacities  as
directors.

   The  terms of  transactions  between  the  Company  and the  Advisor  and its
affiliates  are set forth in Items 11 and 13 below to which  reference is hereby
made for a description of such terms and transactions.

Item 2.  Properties

   As of August 31,  1996,  the Company  has  interests  in the eight  operating
properties  referred  to under Item 1 above to which  reference  is made for the
description, name and location of such properties.

   Occupancy figures for fiscal 1996 are presented below for each property:

                                                 Percent Leased At
                              ------------------------------------------------
                                                                       Fiscal
                                                                       1996
                              11/30/95   2/29/96    5/31/96   8/31/96  Average
                              --------   -------    -------   -------  -------
Independence Village
  of Winston-Salem              88%       90%        90%        93%      90%

Independence Village
  of East Lansing               96%       97%        94%        91%      95%

Independence Village of Raleigh 98%       99%        98%        98%      98%

Independence Village of Peoria  86%       89%        89%        91%      89%

Crown Pointe Apartments         99%       98%        98%        99%      99%

Sedgwick Plaza Apartments       83%       86%        84%        83%      84%

West Shores                     98%       97%        95%        94%      96%

Villa Santa Barbara             59%       64%        69%        81%      68%

Item 3.  Legal Proceedings

      On July 29, 1996,  ILM I Lease  Corporation  and ILM Holding,  Inc.  ("the
Companies")  terminated the property  management  agreement with Angeles Housing
Concepts,  Inc. ("AHC") covering the eight senior housing  facilities  leased by
ILM I Lease  Corporation  from ILM Holding,  Inc.,  the  Company's  consolidated
affiliate.  The  management  agreement  was  terminated  for cause  pursuant  to
Sections 1.05 (a) (i), (iii) and (iv) of the agreement.  Simultaneously with the
termination of the management  agreement,  the Companies,  together with certain
affiliated entities,  filed suit against AHC in the United States District Court
for the Eastern District of Virginia for breach of contract, breach of fiduciary
duty and fraud.  ILM I Lease  Corporation and ILM Holding,  Inc. allege that AHC
willfully  performed  actions   specifically  in  violation  of  the  management
agreement  and that such actions  caused  damages to the  Companies.  Due to the
termination  of the agreement  for cause,  no  termination  fee was paid to AHC.
Subsequent  to the  termination  of the  management  agreement,  AHC  filed  for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed  AHC's case  effective  October 15, 1996. In November  1996, AHC filed
with the  Virginia  District  Court an  Answer  in  response  to the  litigation
initiated by the  Companies  and a  Counterclaim  against ILM Holding,  Inc. The
Counterclaim alleges that the management agreement was wrongfully terminated for
cause and requests  damages which include the payment of the  termination fee in
the amount of  $1,250,000,  payment of management  fees pursuant to the contract
from August 1, 1996 through  October 15, 1996,  which is the earliest  date that
the management  agreement could have been terminated without cause, and recovery
of attorney's fees and expenses.  PaineWebber  Independent Living Mortgage Fund,
Inc.   guaranteed  the  payment  of  the  termination  fee  at  issue  in  these
proceedings.  The  Companies  intend  to  diligently  prosecute  the case and to
vigorously  defend the  counterclaims  made by AHC. The eventual outcome of this
termination dispute cannot presently be determined.

     In  November  1994,  a series of  purported  class  actions  (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York concerning PaineWebber Incorporated's sale and
sponsorship of various limited partnership interests and common stock, including
the  securities  offered by the  Company.  The  lawsuits  were  brought  against
PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"),
among others,  by allegedly  dissatisfied  investors.  In March 1995,  after the
actions were consolidated under the title In re PaineWebber  Limited Partnership
Litigation,  the plaintiffs  amended their  complaint to assert claims against a
variety  of other  defendants,  including  PaineWebber  Properties  Incorporated
("PWPI"),  an affiliate  of  PaineWebber  and the parent  company of the general
partner of the Advisor to the  Company.  On May 30,  1995,  the court  certified
class action treatment of the claims asserted in the litigation.

     The amended complaint in the New York Limited  Partnership  Actions alleged
that, in connection with the sale of common stock of the Company, the defendants
(1) failed to provide adequate disclosure of the risks involved;  (2) made false
and  misleading  representations  about the  safety of the  investments  and the
Company's anticipated performance; and (3) marketed the Company to investors for
whom such  investments  were not suitable.  The plaintiffs,  who purported to be
suing on behalf of all persons who  invested in the Company  also  alleged  that
following the issuance of the Company's  stock,  the  defendants  misrepresented
financial  information  about the Company's value and  performance.  The amended
complaint  alleged that the  defendants  violated the Racketeer  Influenced  and
Corrupt  Organizations  Act  ("RICO")  and  the  federal  securities  laws.  The
plaintiffs  sought  unspecified  damages,  including  reimbursement for all sums
invested by them in the Company's stock, as well as disgorgement of all fees and
other  income  derived  by  PaineWebber  from  the  Company.  In  addition,  the
plaintiffs also sought treble damages under RICO.

     In January 1996,  PaineWebber signed a memorandum of understanding with the
plaintiffs in the class action  outlining the terms under which the parties have
agreed to  settle  the  case.  Pursuant  to that  memorandum  of  understanding,
PaineWebber  irrevocably  deposited  $125  million into an escrow fund under the
supervision of the United States District Court for the Southern District of New
York to be used to  resolve  the  litigation  in  accordance  with a  definitive
settlement agreement and a plan of allocation. On July 17, 1996, PaineWebber and
the class plaintiffs submitted a definitive  settlement agreement which has been
preliminarily  approved by the court and provides for the complete resolution of
the class  action  litigation,  including  releases  in favor of the Company and
PWPI, and the allocation of the $125 million  settlement fund among investors in
the  various  partnerships  and  REITs  at  issue  in the  case.  As part of the
settlement,  PaineWebber  also  agreed to provide  class  members  with  certain
financial guarantees relating to some of the partnerships and REITs. The details
of the settlement are described in a notice mailed  directly to class members at
the  direction  of the court.  A final  hearing on the  fairness of the proposed
settlement is scheduled to continue in December 1996.

     In February 1996,  approximately  150 plaintiffs  filed an action  entitled
Abbate v.  PaineWebber  Inc. in  Sacramento,  California  Superior Court against
PaineWebber   Incorporated  and  various  affiliated   entities  concerning  the
plaintiffs'  purchases  of  various  limited  partnership  investments  and REIT
stocks,  including those offered by the Company.  The complaint  alleges,  among
other things,  that  PaineWebber  and its related  entities  committed fraud and
misrepresentation and breached fiduciary duties allegedly owed to the plaintiffs
by selling or  promoting  limited  partnership  and REIT  investments  that were
unsuitable for the plaintiffs and by overstating the benefits,  understating the
risks and  failing to state  material  facts  concerning  the  investments.  The
complaint seeks  compensatory  damages of $15 million plus punitive damages.  In
September 1996, the court dismissed many of the plaintiffs'  claims as barred by
applicable securities arbitration regulations.

      In June  1996,  approximately  50  plaintiffs  filed  an  action  entitled
Bandrowski v. PaineWebber Inc. in Sacramento,  California Superior Court against
PaineWebber   Incorporated  and  various  affiliated   entities  concerning  the
plaintiff's  purchases of various limited partnership interests and REIT stocks,
including those offered by the Company.  The complaint is substantially  similar
to the complaint in the Abbate action described  above,  and seeks  compensatory
damages of $3.4 million plus punitive damages.

     In July 1996,  approximately 15 plaintiffs filed an action entitled Barstad
v.  PaineWebber  Inc.  in  Maricopa  County,   Arizona  Superior  Court  against
PaineWebber   Incorporated  and  various  affiliated   entities  concerning  the
plaintiffs'  purchases of various limited partnership interests and REIT stocks,
including those offered by the Company.  The complaint is substantially  similar
to the complaint in the Abbate action described  above,  and seeks  compensatory
damages of $752,000 plus punitive damages.

     With respect to the Abbate, Bandrowski and Barstad actions described above,
the  defendants'  time to move  against  or answer  the  complaints  has not yet
expired. In all cases, PaineWebber intends to vigorously contest the allegations
of the  actions.  However,  the  eventual  outcome  of this  litigation  and the
potential impact, if any, on the Company's  shareholders cannot be determined at
the present  time.  Mediation  hearings on the  Abbate,  Bandrowski  and Barstad
actions are currently scheduled to be held in December 1996.

     Under certain limited circumstances, pursuant to the Advisor Agreement with
the Advisor and other contractual  obligations,  PaineWebber affiliates could be
entitled to indemnification  for expenses and liabilities in connection with the
shareholder litigation matters described above. However,  PaineWebber has agreed
not to seek  indemnification for any amounts it is required to pay in connection
with the settlement of the New York Limited Partnership  Actions. At the present
time, neither PaineWebber nor management of the Company can estimate the impact,
if  any,  of  any of  the  potential  indemnification  claims  on the  Company's
financial statements, taken as a whole.

Item 4.  Submission of Matters to a Vote of Security Holders

    None.


<PAGE>

                                   PART II

Item 5.  Market for the Registrant's Shares and Related Stockholder Matters

      During the public  offering  period,  which commenced on June 21, 1989 and
ended on July 21, 1989,  the selling price of the shares of common stock was $10
per share. At August 31, 1996,  there were 5,348 record holders of the Company's
shares.  There is no public  market for the resale of the shares,  and it is not
anticipated that a public market will develop.

      The Company makes  quarterly  distributions,  payable within 45 days after
the end of each fiscal quarter, to shareholders of record on the record date for
such  quarter  as  determined  by the  Directors.  The  Company  intends to make
distributions  to shareholders in an amount equal to at least 95% of its taxable
income in order to  continue to qualify as a REIT.  Reference  is made to Item 6
below for the amount of cash  dividends  paid per share of common  stock  during
fiscal 1996.

Item 6.  Selected Financial Data

              PaineWebber Independent Living Mortgage Fund, Inc.
        For the years ended August 31, 1996, 1995, 1994, 1993 and 1992
                    (In thousands, except per share data)

                             1996 (1)      1995     1994 (2) 1993 (2) 1992 (2)
                             --------      ----     -------- -------- --------

Revenues                    $  6,473    $ 16,437   $ 14,860 $ 13,190 $ 10,168

Operating income            $  4,115    $  4,099   $  2,904 $  2,060 $    201

Gain on sale of U. S. 
  Treasury Note                    -           -          - $     82        -

Net income                  $  4,115    $  4,099   $  2,904 $  2,142 $    201

Earnings per share of
 common stock               $   0.55    $   0.54   $   0.39 $   0.28 $   0.03 


Cash dividends paid
 per share of common stock  $   0.70    $   0.71   $   0.40 $   0.70 $   1.00

Total assets                $ 41,453    $ 44,211   $ 44,241 $ 43,776 $ 46,859

  (1) As discussed further in Item 7, effective  September 1, 1995 the operating
      properties  in which the Company has invested were leased by the Company's
      consolidated  affiliate  to ILM I Lease  Corporation  pursuant to a master
      lease  agreement.  The master lease is a  "triple-net"  lease  whereby the
      Lessee pays all operating  expenses,  governmental  taxes and assessments,
      utility  charges  and  insurance  premiums,  as well as the  costs  of all
      required maintenance,  personal property and non-structural  repairs. As a
      result of the commencement of the master lease, the Company's consolidated
      gross  revenues and expenses  declined  significantly  in fiscal 1996 from
      prior year levels.

  (2) As a result of certain  restructuring  plans  which the  Company  began to
      implement  during  fiscal 1995 (see Item 7), the  financial  position  and
      results of operations of the combined operating  investment  properties in
      which the Company has invested have been presented on a consolidated basis
      in the Company's financial  statements  beginning in fiscal 1995. Prior to
      fiscal  1995,  the  Company  had  accounted  for  its  interests  in  such
      properties  under  the  equity  method.  In  order to  present  comparable
      financial  data, the amounts  depicted above have been restated to portray
      the operating properties on a consolidated basis for all years. The effect
      of such  restatement  does not change the net income or earnings per share
      amounts  previously  reported.  See the  Notes to  Consolidated  Financial
      Statements accompanying this Annual Report for a further discussion.

    The above selected  financial  data should be read in  conjunction  with the
financial  statements  and  related  notes  appearing  elsewhere  in this Annual
Report.

    The above  earnings  and cash  dividends  paid per share of common stock are
based upon the 7,520,100 shares outstanding during each year.

Item 7.   Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of Operations

Liquidity and Capital Resources

   The Company  offered  shares of its common  stock to the public from June 21,
1989 to July 21,  1989  pursuant  to a  Registration  Statement  filed under the
Securities Act of 1933.  Capital  contributions  of $75,201,000 were received by
the Company  (including  $201,000  contributed by PaineWebber  Group, Inc.) and,
after  deducting  selling  expenses and offering costs and allowing for adequate
cash  reserves,  approximately  $62.8  million was  available  to be invested in
participating  first mortgage loans secured by Senior  Housing  Facilities.  The
Company  originally  invested the net proceeds of the initial public offering in
eight participating  mortgage loans secured by Senior Housing Facilities located
in seven different states.  All of the loans made by the Company were originally
with Angeles  Housing  Concepts,  Inc.  ("AHC"),  a company  specializing in the
development,   acquisition  and  operation  of  Senior  Housing  Facilities.  As
previously  reported,  AHC  defaulted on the regularly  scheduled  mortgage loan
payments  due to the  Company  on March 1,  1993 as a  result  of the  financial
problems  of  its  parent  company,  Angeles  Corporation   ("Angeles"),   which
subsequently  filed for bankruptcy.  In fiscal 1994, a settlement  agreement was
executed whereby ownership of the properties was transferred from AHC to certain
designated affiliates of the Company. Subsequently, these affiliates were merged
into ILM Holding,  Inc.  ("ILM  Holding").  The capital  stock of ILM Holding is
owned by the Company and PWP  Holding,  Inc.  ("PWP  Holding"),  a  wholly-owned
subsidiary of PaineWebber  Properties  Incorporated  ("PWPI").  PWPI is a wholly
owned subsidiary of PaineWebber Incorporated, which is a wholly owned subsidiary
of PaineWebber Group, Inc. ("PaineWebber").  The Company holds substantially all
of the  economic  ownership  in ILM  Holding,  while PWP  Holding  holds  voting
control.  As part of the fiscal 1994 settlement  agreement with AHC, ILM Holding
retained AHC as the property  manager for all of the Senior  Housing  Facilities
pursuant to the terms of a management agreement. As discussed further below, the
management agreement with AHC was terminated in July 1996.

      Subsequent to the effective date of the Settlement  Agreement with AHC, in
order to maximize  the  potential  returns to the  existing  shareholders  while
maintaining  the Company's  qualification  as a REIT under the Internal  Revenue
Code, the Company formed a new  corporation,  ILM I Lease  Corporation,  for the
purpose of operating the Senior Housing  Facilities  under the terms of a master
lease  agreement.  As of August  31,  1995,  ILM I Lease  Corporation,  which is
taxable  as a  regular  C  Corporation  and  not as a REIT,  was a  wholly-owned
subsidiary of the Company.  On September 1, 1995, after the Company received the
required regulatory approval,  it distributed all of the shares of capital stock
of ILM I Lease  Corporation  to the  holders of record of the  Company's  common
stock. One share of common stock of ILM I Lease  Corporation was issued for each
full share of the Company's  common stock held. Prior to the  distribution,  the
Company capitalized ILM I Lease Corporation with $700,000 from its existing cash
reserves,  which was an amount estimated to provide ILM I Lease Corporation with
necessary  working  capital.  The master  lease  agreement,  which  commenced on
September 1, 1995, is initially  between the Company's  consolidated  affiliate,
ILM Holding,  as owner of the properties and Lessor, and ILM I Lease Corporation
as Lessee.  The master lease is a "triple-net" lease whereby the Lessee pays all
operating  expenses,  governmental  taxes and  assessments,  utility charges and
insurance premiums, as well as the costs of all required  maintenance,  personal
property and  non-structural  repairs in  connection  with the  operation of the
Senior Housing  Facilities.  ILM Holding,  as the Lessor, is responsible for all
major  capital  improvements  and  structural  repairs  to  the  Senior  Housing
Facilities.  During the  initial  term of the  master  lease,  which  expires on
December 31, 1999, ILM I Lease  Corporation is obligated to pay annual base rent
for the use of all of the  Facilities in the aggregate  amount of $5,886,000 for
calendar  year  1995  (prorated  based  on  the  lease  commencement  date)  and
$6,364,800 for calendar year 1996 and each subsequent year. Beginning in January
1997 and for the remainder of the lease term, ILM I Lease  Corporation will also
be obligated to pay variable rent for each Facility.  Such variable rent will be
payable  quarterly  and will equal 40% of the excess,  if any, of the  aggregate
total revenues for the Facilities, on an annualized basis, over $16,996,000.

      The assumption of ownership of the properties  through ILM Holding,  which
is  presently  a regular C  corporation  for tax  purposes,  has  resulted  in a
possible  future tax liability  which would be payable upon the ultimate sale of
the  properties  (the  "built-in  gain  tax").  The  amount of such tax would be
calculated  based on the  lesser of the total  net gain  realized  from the sale
transaction  or the portion of the net gain  realized upon a final sale which is
attributable  to the  period  during  which the  properties  were held by in a C
corporation.  The final phase of the Company's  restructuring plans involves the
conversion  of ILM Holding to a REIT for tax  purposes.  Certain  changes to the
ownership  structure of ILM Holding which are necessary in order for ILM Holding
to qualify as a REIT under the Internal  Revenue Code are expected to be made in
time for ILM Holding to elect REIT status in conjunction  with the filing of its
calendar 1996 federal tax return.  Any future  appreciation  in the value of the
Senior Housing Facilities  subsequent to the conversion of ILM Holding to a REIT
would not be subject to the built-in  gain tax. The built-in gain tax would most
likely  not be  incurred  if the  properties  were to be held for a period of at
least  10  years  from  the date of the  conversion  of ILM  Holding  to a REIT.
However,  since the end of the Company's original  anticipated holding period is
less  than 4 years  away,  the  properties  are not  expected  to be held for an
additional 10 years.  The Board of Directors  may defer the Company's  scheduled
liquidation  date,  if in  the  opinion  of a  majority  of the  Directors,  the
disposition  of the  Company's  assets at such time  would  result in a material
under-realization of the value of such assets;  provided,  however, that no such
deferral may extend  beyond  December 31, 2004.  Based on  management's  current
estimate of the  increase  in the values of the  properties  which has  occurred
since April 1994,  as supported by  independent  appraisals,  ILM Holding  would
incur a  sizable  tax if the  properties  were  sold.  Based  on  these  current
estimated market values of the operating investment  properties,  a sale at such
values prior to the end of the 10-year holding period could result in a built-in
gain tax of as much as $2.9 million. As the holder of a 99% economic interest in
ILM Holding,  the burden of this built-in  gain tax would be primarily  borne by
the Company.

      As the Company has previously disclosed, the Company's restructuring plans
involve the transfer of ownership of the Senior Housing  Facilities,  along with
the related leasehold interests, to the Company or its wholly-owned  subsidiary.
The REIT  requirements  had  previously  restricted the Company from owning more
than a minimum amount of voting stock in ILM Holding.  Since ILM Holding will be
a REIT  effective  as of  January  1,  1996,  these  restrictions  are no longer
applicable  to the Company.  The  restructuring  plans are  consistent  with the
Company's consolidated  accounting policy and would allow greater flexibility to
provide future liquidity to the Company and its shareholders. In accordance with
these  restructuring  plans and in connection with the conversion of ILM Holding
to a REIT,  on November  21,  1996,  the Company  requested  that PWPI cause PWP
Holding  to sell all of the stock  held by PWP  Holding  in ILM  Holding  to the
Company for a price equal to the fair market  value of the 1% economic  interest
in ILM Holding  represented  by the stock and that the sale be completed as soon
as possible.  PWPI has not taken a position with respect to this request. Should
PWPI  determine  not to  agree  to the  Company's  request  to  comply  with the
previously disclosed  restructuring plans, the Company will consider any and all
courses of action available to it with respect to PWPI.

      ILM Holding has acquired the respective  operating  properties subject to,
and assumed the  obligations  under,  the mortgage loans payable to the Company,
pursuant to the  Settlement  Agreement  with AHC. The principal  balance of each
loan was modified to reflect the estimated  fair value of the related  operating
property  as of the  date of the  transfer  of  ownership.  The  modified  loans
required  interest-only payments on a monthly basis at a rate of 9.5% from April
1, 1994  through  December 1, 1994,  11% for the period from  January 1, through
December 31,  1995,  12.5% for the period  January 1 through  December 31, 1996,
13.5% for the period  January 1 through  December 31,  1997,  14% for the period
January 1 through  December  31,  1998 and 14.5% for the period  January 1, 1999
through  maturity.  Since ILM  Holding is  consolidated  with the Company in the
accompanying  financial  statements,  the  mortgage  loans and related  interest
expense have been  eliminated  in  consolidation.  Because the  ownership of the
assets of ILM  Holding  was  expected  to be  transferred  to the Company or its
wholly-owned  subsidiary,  ILM Holding was capitalized  with funds to provide it
with working capital only for a limited period of time. At the present time, ILM
Holding is not expected to have  sufficient  cash flow during fiscal 1997 to (i)
meet its obligations to make the debt service payments due under the loans, (ii)
pay for capital improvements and structural repairs in accordance with the terms
of the master  lease,  and (iii) pay for costs that may be incurred in defending
AHC's  Counterclaim  against  ILM  Holding,  as  discussed  further  below.  The
liquidation of ILM Holding in connection with the Company's  restructuring plans
would  eliminate the  existence of the  outstanding  mortgage  loans between the
Company and ILM  Holding.  If,  however,  the Company is unable to complete  its
restructuring  plans due to PWPI's  refusal to cause PWP  Holding to sell to the
Company its voting  stock in ILM  Holding,  the  Company  may incur  substantial
additional costs and suffer other adverse consequences.

      On  July  29,  1996,  ILM  I  Lease  Corporation  and  ILM  Holding  ("the
Companies")  terminated the property management  agreement with AHC covering the
eight  senior  housing  facilities  leased by ILM I Lease  Corporation  from ILM
Holding. The management agreement was terminated for cause pursuant to the terms
of  the  contract.   Simultaneously  with  the  termination  of  the  management
agreement, the Companies,  together with certain affiliated entities, filed suit
against AHC in the United  States  District  Court for the  Eastern  District of
Virginia for breach of contract, breach of fiduciary duty and fraud. ILM I Lease
Corporation  and  ILM  Holding  allege  that  AHC  willfully  performed  actions
specifically  in violation  of the  management  agreement  and that such actions
caused  damages to the  Companies.  Due to the  termination of the agreement for
cause, no termination fee was paid to AHC.  Subsequent to the termination of the
management  agreement,  AHC filed for  protection  under  Chapter 11 of the U.S.
Bankruptcy  Code in its domestic state of California.  The filing was challenged
by the  Companies,  and the  Bankruptcy  Court  dismissed  AHC's case  effective
October 15, 1996. In November 1996,  AHC filed with the Virginia  District Court
an Answer  in  response  to the  litigation  initiated  by the  Companies  and a
Counterclaim  against ILM Holding.  The Counterclaim alleges that the management
agreement was wrongfully terminated for cause and requests damages which include
the  payment  of the  termination  fee in the amount of  $1,250,000,  payment of
management fees pursuant to the contract from August 1, 1996 through October 15,
1996,  which is the earliest date that the management  agreement could have been
terminated  without  cause,  and  recovery  of  attorney's  fees  and  expenses.
PaineWebber Independent Living Mortgage Fund, Inc. guaranteed the payment of the
termination  fee  at  issue  in  these  proceedings.  The  Companies  intend  to
diligently prosecute the case and to vigorously defend the counterclaims made by
AHC.  The  eventual  outcome of this  termination  dispute  cannot  presently be
determined.  Accordingly, no provision for any liability which might result from
the  Company's  guaranty  of  the  termination  fee  has  been  recorded  in the
accompanying financial statements.

      ILM I Lease  Corporation  has retained  Capital Senior  Management 2, Inc.
("Capital")  of  Dallas,  Texas  to be the new  manager  of the  Senior  Housing
Facilities pursuant to a Management  Agreement which commenced on July 29, 1996.
Under the terms of the Agreement,  Capital will earn a Base Management Fee equal
to 4% of the Gross  Operating  Revenues  of the Senior  Housing  Facilities,  as
defined. Capital will also be eligible to earn an Incentive Management Fee equal
to 25% of the amount by which the  average  monthly  Net Cash Flow of the Senior
Housing Facilities,  as defined,  for the twelve month period ending on the last
day of each  calendar  month  exceeds a specified  Base Amount.  Each August 31,
beginning on August 31, 1997,  the Base Amount will be increased  annually based
on the percentage increase in the Consumer Price Index.  PaineWebber Independent
Living Mortgage Fund, Inc. has guaranteed the payment of all fees due to Capital
under the terms of the Management Agreement.

      The eight  properties  in which the  Company  has  invested  averaged  92%
occupancy as of August 31, 1996. As previously  reported,  a property renovation
and  assisted-living  conversion  program  has been in  progress  at Villa Santa
Barbara  for the past two  years.  Phase  one of the  renovations  at the  Santa
Barbara facility, which was completed during fiscal 1995, included renovation of
the lobby, dining room, library,  activities room,  television and game room and
the laundry rooms. Phase two of the renovation program,  which was substantially
completed  during  the first  quarter of fiscal  1996,  involved  interior  unit
improvements,  hallway  upgrades and the conversion of existing  studio units to
assisted   living  units.   The  total  cost  of  the  renovation   program  was
approximately $1.2 million,  which has been funded 25% by the Company and 75% by
PaineWebber  Independent  Living Mortgage Inc. II ("ILM2") from funds previously
reserved for such  improvements.  Leasing gains at Villa Santa Barbara have been
slowed by delays in  completing  the capital  improvements  and in obtaining the
required  regulatory  licensing to begin leasing the new assisted  living units.
During the quarter  ended May 31,  1996,  ILM I Lease  Corporation  received the
required  assisted living licenses.  Leasing of the 38 new assisted living units
is now well underway.  Overall occupancy of Villa Santa Barbara averaged 81% for
the fourth quarter of fiscal 1996.

      The road  adjacent to the  Raleigh  facility  is being  improved,  and the
county  Department  of  Transportation  has  requested a temporary  construction
easement on the  property.  Although the easement  will not directly  affect the
operation of the facility, it will likely result in the removal of several trees
that currently provide a buffer between the building and the road.  Negotiations
are  currently  underway  to  minimize  the  removal  of trees  and to  secure a
settlement  from the county that will pay for installing a new landscape  buffer
upon the completion of the roadway construction.

      The Company's net operating cash flow is expected to be relatively  stable
and predictable now that the master lease structure is in place. The annual base
rental payments owed to ILM Holding increased to $6,364,800 effective January 1,
1996 and will  remain at that  level for the  remainder  of the lease  term.  In
addition,  the Senior Housing Facilities are currently generating gross revenues
which are slightly in excess of the  specified  threshold  in the variable  rent
calculation,  as discussed  further  above,  which becomes  effective in January
1997.  Accordingly,  the Company expects that ILM Holding will receive  variable
rent  payments in fiscal 1997.  As a result of the status of the  Company's  net
operating cash flow under the current master lease  arrangement,  the Company is
expected to be able to increase its quarterly  dividend  payment from $0.175 per
share to $0.1875  per share  effective  with the  dividend to be paid in January
1997 for the quarter ended November 30, 1996. This expected increase would raise
the dividend  payment to the  equivalent of a 7.5% annual return on the original
offering price of the Company's  common stock. As noted above,  ILM Holding,  as
Lessor, is responsible for major capital  improvements and structural repairs to
the Senior Housing  Facilities.  Management is currently  reviewing with the new
property management team annual operating budgets and capital expenditure plans,
which include an ongoing program to replace  air-conditioning units at the Santa
Barbara  facility and a potential  program to upgrade the overall  appearance of
the  Winston-Salem  property.  In  addition,  management  plans to continue  its
investigation  of  the  potential  for  the  expansion  of the  assisted  living
capacities of the properties in certain markets where demand for assisted living
units is  particularly  high.  Depending  on the extent of any  assisted  living
expansions  deemed  appropriate,  such  plans  could  result  in  the  need  for
substantial capital improvement funds.

      At  August  31,  1996,  the  Company  had  cash and  cash  equivalents  of
$3,010,000.  Such amounts will be used for the working  capital  requirements of
the Company,  along with the possible  investment in the properties owned by the
Company's  consolidated  affiliate  for certain  capital  improvements,  and for
dividends to the  shareholders.  Future capital  improvements  could be financed
from  operations  or  through  borrowings,  depending  on the  magnitude  of the
improvements,  the  availability  of  financing  and the  Company's  incremental
borrowing rate. The source of future liquidity and dividends to the shareholders
is expected to be through  master lease  payments from ILM I Lease  Corporation,
interest  income  earned on invested  cash reserves and proceeds from the future
sales  of the  underlying  operating  investment  properties.  Such  sources  of
liquidity  are  expected  to  be  adequate  to  meet  the  Company's   operating
requirements  on both a short-term and long-term  basis.  The Company  generally
will be obligated to distribute  annually at least 95% of its taxable  income to
its  Shareholders  in order to continue to qualify as a REIT under the  Internal
Revenue Code.

Results of Operations
1996 Compared to 1995

      Net income  increased  by $16,000 for fiscal  1996,  when  compared to the
prior year. The primary  reasons for this increase in net income is decreases in
professional   fees  and  management  and  advisory  fees  during  fiscal  1996.
Professional fees decreased by $294,000 as a result of the significant amount of
legal and tax advisory  services  incurred in the prior year in connection  with
the  evaluation,  selection  and  implementation  of the master  lease  property
ownership structure  described above.  Management and advisory fees decreased by
$114,000 as a result of the advisory fees charged to the Company's  consolidated
affiliate  during  fiscal  1995.  Such  fees  were  equal  to 0.5% of the  Gross
Operating Revenues of the Senior Housing Facilities. These advisory fees were no
longer charged to ILM Holding effective  September 1, 1995 upon the commencement
of the master lease.

      The favorable  changes in net income were partially  offset by the effects
of the  commencement  of the master  lease  between the  Company's  consolidated
affiliate and ILM I Lease Corporation  effective September 1, 1995, as discussed
further above and in the notes to the  accompanying  financial  statements.  The
Company,  through its consolidated  affiliate,  now receives master lease rental
income from ILM I Lease Corporation rather than the revenues from the individual
tenants of the Senior Housing  Facilities.  In addition,  under the terms of the
master lease, all property  operating expenses are now the responsibility of the
Lessee.  The master lease rental income earned by the Company during fiscal 1996
was  $395,000  less than the  excess of rental  income  earned  from the  Senior
Housing Facilities over property operating expenses and property management fees
during the prior year.  In  addition,  a decrease in interest  income of $53,000
also partially  offset the  improvement  in net income in fiscal 1996.  Interest
income  decreased  due to a  decline  in the  average  amount  of cash  and cash
equivalents  outstanding  when  compared  to the  prior  year.  The  decline  in
outstanding  cash reserves was primarily the result of the Company's  funding of
the $700,000  initial working capital  investment in ILM I Lease  Corporation on
September 1, 1995.

1995 Compared to 1994

      The Combined  Facilities  generated  rental  revenues of  $16,239,000  for
fiscal 1995,  as compared to  $14,771,000  for the prior year.  This increase of
$1,468,000,  or 10%, along with a decrease in depreciation  and  amortization of
$234,000,  were the primary  reasons that the Company's net income improved from
$2,904,000 for fiscal 1994 to $4,099,000 for fiscal 1995. The increase in rental
revenues  was mainly the result of an  increase  in  effective  rental  rates at
certain of the Facilities.  Overall portfolio  occupancy increased slightly from
an average of 87% for fiscal 1994 to 89% for fiscal  1995.  The biggest  leasing
gains  were  achieved  at the  Winston-Salem  and  Raleigh  properties.  Average
occupancy at Winston-Salem improved to 84% for fiscal 1995 from an average level
of 65% for the prior year.  Likewise,  average occupancy at Raleigh increased to
98% from 89% over the same period.  The occupancy  level at the Peoria  property
dropped  during  fiscal  1995 to an  average  of 82% from a level of 88% for the
prior year, and the occupancy level at Sedgwick Plaza declined to 86% for fiscal
1995 from an average of 93% in fiscal 1994.  Occupancy  levels at Crown  Pointe,
East Lansing and West Shores remained  relatively steady, in the mid-to-high 90%
range  during  both  years.  However,  revenues  were  up  at  these  stabilized
properties  because management was able to implement rental rate increases while
maintaining  stable  occupancy  levels.   Occupancy  and  rental  revenues  were
relatively  unchanged  at Villa Santa  Barbara due to the pending  status of the
property's  assisted living license,  as discussed  further above.  Depreciation
expense decreased due to the full year effect of the change in the cost basis of
the Facilities  upon the transfer of ownership of the Facilities  which occurred
in April  1994,  as  discussed  further  in the  Notes to  Financial  Statements
accompanying this Annual Report.

      Property operating expenses increased by $300,000, or 4%, for fiscal 1995,
partially  offsetting  the  improvement  in  revenues.  The increase in property
operating  expenses was primarily  attributable to higher variable food service,
housekeeping,  activities and assisted living costs  associated with the overall
increase  in the  portfolio  occupancy  level.  However,  the change in property
operating  expenses also  reflected a decrease in marketing  costs at certain of
the Facilities that had achieved stabilized  occupancy levels and the effects of
certain operating efficiencies  implemented at most of the Facilities subsequent
to the transfer of  ownership.  Increases in  management  and advisory  fees and
professional fees for fiscal 1995,  aggregating $265,000,  also served to offset
the favorable  changes in the Company's net operating  results.  Management  and
advisory  fees  increased  as a result of the  advisory  agreement  between  ILM
Holding and an affiliate of PWPI. Such agreement, which was effective from April
1, 1994  through  August  31,  1995,  called for fees equal to 0.5% of the Gross
Operating  Revenues  of the  Facilities  in return  for  certain  administrative
services.  Professional  fees increased during fiscal 1995 mainly as a result of
certain  legal  and tax  advisory  services  required  in  connection  with  the
evaluation,  selection and implementation of the master lease property ownership
structure described above.

1994 Compared to 1993

      The transfer of ownership of the Senior Housing  Facilities in fiscal 1994
resulted in no gain or loss  recognition by the Company for financial  reporting
purposes.   As  previously   reported,   under  generally  accepted   accounting
principles,  the Company had always accounted for its investments in acquisition
and  construction  loans under the equity method,  as if such  investments  were
equity  interests in a joint venture.  Accordingly,  the carrying values of such
investments had been reduced from inception by non-cash depreciation charges and
by payments from AHC,  prior to the default in fiscal 1993, in excess of the net
cash flow generated by the Senior Housing  Facilities  received  pursuant to the
guaranty  agreement  between the Company and AHC. As a result of this accounting
treatment,  the carrying  values of the Company's  investments  had been reduced
below  management's  estimate  of the fair  market  value of the Senior  Housing
Facilities as of the effective  date of the transfer of ownership.  Accordingly,
for financial  reporting purposes the Company continued to employ its historical
cost basis in accounting  for these  investments  subsequent to the transfer and
continued to record its share of the operating  results of the properties in its
income  statement.  For federal income tax purposes,  the investments had always
been carried at the contractually stated principal balances of the participating
mortgage  loans.  For tax purposes only, a loss was recognized by the Company in
1994 in the  amount by which the  stated  principal  balances  of the loans were
reduced as of the date of the transfer of ownership.

      Net income  increased  by  approximately  $762,000  for  fiscal  1994 when
compared to fiscal  1993,  primarily  as a result of an increase in the combined
revenues  of  the  Company's  Senior  Housing   Facilities  and  a  decrease  in
depreciation  expense.  The increase in rental revenues was  attributable to the
lease-up  achieved  at certain of the  Facilities  and the  reduction  in rental
concessions  used at the  Facilities  that  had  achieved  stabilized  occupancy
levels. Combined rental revenues increased by approximately  $1,757,000, or more
than 13%, in fiscal  1994,  which  exceeded  the  increase in combined  property
operating  expenses and property  management fees.  Average portfolio  occupancy
increased from 81% for fiscal 1993 to 87% for fiscal 1994.  Significant  leasing
gains were achieved at six of the eight  Facilities  over this two-year  period.
Occupancy at the Sedgwick Plaza and Crown Pointe Facilities remained stable over
this period in the mid-to-high 90% range.  Average  effective annual revenue per
square foot at Crown Pointe  increased  from $27 in fiscal 1993 to $28 in fiscal
1994.  The increase in combined  property  operating  expenses in fiscal 1994 of
approximately  $805,000,  or 11%,  primarily  reflected  an increase in variable
operating costs associated with the overall increase in portfolio occupancy. The
decrease in depreciation expense, of approximately  $234,000,  resulted from the
reduction in the carrying  values of the Facilities upon the assumption of title
from AHC.

      The  favorable  change in the  operating  results  of the  Senior  Housing
Facilities  was  partially  offset by  increases  in the  Company's  general and
administrative  expenses  and  professional  fees and a decrease in interest and
other  income in fiscal 1994.  Interest  and other income  decreased by $81,000,
professional  fees were up  $214,000  and general  and  administrative  expenses
increased  by $73,000.  The decrease in interest and other income was partly due
to the disposition in fiscal 1993 of an investment in a U.S. Treasury Note which
yielded a  significantly  higher  rate of return  than the return on  short-term
money-market investments. The disposition of the investment in the U.S. Treasury
Note also  resulted  in a gain of  approximately  $82,000  in fiscal  1993.  The
decrease in interest  income was also  partly  attributable  to a decline in the
average  outstanding  balance of the Company's cash and cash equivalents  during
fiscal 1994. The increase in professional fees expenses was mainly the result of
increased legal costs related to the AHC loan defaults and management's  efforts
to protect the Company's interest in the underlying collateral.  The increase in
general and  administrative  expenses was also primarily due to additional costs
incurred in connection with the AHC loan defaults.

      A decline in management fees of $77,000 in fiscal 1994 also contributed to
the  increase  in  net  income.  Management  fee  expense  decreased  due to the
reduction in the quarterly  dividend,  beginning with the quarter ended February
28, 1993, from $0.25 per share to $0.10 per share. The dividend reduction, which
resulted from the loan  defaults,  reduced the  shareholders'  rate of return on
original  shareholders'  equity  to  below  10% per  annum.  Despite  subsequent
increases in the quarterly dividend rates, the rate of return remains below this
10% threshold on original  equity.  Accordingly,  the Advisor has not earned any
incentive management fees since the first quarter of fiscal 1993.

Inflation

      The Company  completed its seventh full year of operations in fiscal 1996.
The  effects  of  inflation  and  changes in prices on the  Company's  operating
results to date have not been significant.

      Inflation in future periods is likely to cause  increases in the Company's
expenses,  which may be  partially  offset by  increases  in  revenues  from the
Company's  investments in the Senior Housing Facilities.  Under the terms of the
master lease, as discussed further above, the Company,  through its consolidated
affiliate, ILM Holding, will earn additional rental income based on increases in
the gross  revenues of the related  operating  properties  beginning  in January
1997. Such gross revenues may tend to rise with inflation since the rental rates
on the tenant leases,  which are  short-term in nature,  can be adjusted to keep
pace with inflation as market conditions allow.



<PAGE>


Item 8.  Financial Statements and Supplementary Data

      The financial statements and supplementary data are included under Item 14
of this Annual Report.

Item 9.   Changes in and  Disagreements  with  Accountants  on  Accounting  and
Financial Disclosure

      None.


<PAGE>


                                   PART III

Item 10.  Directors and Executive Officers of the Registrant

      There are  currently  five  directors of the  Company,  none of whom is an
affiliate of the Advisor.  The  directors  are subject to removal by the vote of
the  holders  of a  majority  of  the  outstanding  shares.  The  directors  are
responsible for the general  policies of the Company,  but they are not required
to  personally  conduct  the  business  of the  Company in their  capacities  as
directors.

      (a) and (b) The names and ages of the directors  and executive  officers
of the Company are as follows:

                                                                     Date
                                                                     elected
  Name                        Office                           Age   to Office
  ----                        ------                           ---   ---------

Lawrence A. Cohen       President, Chief Executive Officer
                          and Director                         43     5/15/91
Jeffry R. Dwyer         Director                               50     6/9/89 *
J. William Sharman, Jr. Director                               56     6/9/89 *
Carl J. Schramm         Director                               50     12/5/96
Julien G. Redele'       Director                               61     12/5/96
Walter V. Arnold        Senior Vice President, Chief Financial
                          Officer and Treasurer                 49    6/9/89 *
James A. Snyder         Senior Vice President                   51    7/6/92
C. David Carlson        Vice President                          48    12/11/95
Dorothy F. Haughey      Secretary                               70    6/9/89 *

*  The date of incorporation of the Company.

    (c) ILM REIT Advisor,  Inc., the general  partner of the Advisor,  assists
the  directors  and officers of the Company in the  management  and control of
the Company's  affairs.  ILM REIT Advisor,  Inc. is a wholly-owned  subsidiary
of  PaineWebber  Properties  Incorporated  ("PWPI").  The principal  executive
officers of ILM REIT Advisor, Inc. are as follows:

      Name                      Office                        Age
      ----                      ------                        ---

Bruce J. Rubin          President and Chief Executive Officer  37
Walter V. Arnold        Senior Vice President, Chief
                          Financial Officer and Treasurer      49
James A. Snyder         Senior Vice President                  51
C. David Carlson        Vice President                         48

    (d) There is no family  relationship among any of the foregoing directors or
officers.  All of the foregoing  directors and officers of the Company have been
elected to serve until the Company's next annual meeting.

    (e)  The  business  experience  of  each of the  directors  and  executive
officers of the Company and ILM REIT Advisor, Inc. is as follows:

      Lawrence A. Cohen has served as President,  Chief  Executive  Officer and
Director of the Company  since 1991.  Mr. Cohen is also Vice Chairman and Chief
Financial  Officer of Capital  Senior  Living  Corp.,  an  affiliate of Capital
Senior  Management 2, Inc.,  which is the company that was  contracted by ILM I
Lease Corporation in July 1996 to perform property  management services for the
Senior Housing  Facilities in which the Company has invested.  Mr. Cohen joined
Capital  Senior  Living Corp.  in November  1996.  Mr. Cohen was  President and
Chief  Executive  Officer of PWPI until August  1996.  Mr. Cohen joined PWPI in
January 1989 as its  Executive  Vice  President  and Director of Marketing  and
Sales.  Mr.  Cohen is also a member of the board of  directors  of  PaineWebber
Independent  Living Mortgage Inc. II (ILM2),  ILM I Lease  Corporation,  ILM II
Lease  Corporation  and  Retail  Property  Investors,  Inc.  (RPI).  Mr.  Cohen
received his LL.M (in Taxation) from New York University  School of Law and his
J.D.  degree from St. John's  University  School of Law. Mr. Cohen received his
B.B.A. degree in accounting from George Washington  University.  He is a member
of the New York Bar and is a Certified Public Accountant.

      Jeffry  R.  Dwyer  has  served  as a  director  of the  Company  since its
inception  in 1989.  Mr.  Dwyer is a  partner  with the law firm of Akin,  Gump,
Straus, Hauer & Feld in the District of Columbia, which he joined in 1993. Prior
to joining Akin,  Gump,  Straus,  Hauer & Feld, Mr. Dwyer was a partner with the
law firm of Morrison & Foerster from 1989 to 1993.  Immediately prior to joining
Morrison & Foerster,  Mr. Dwyer was a partner with the law firm of Lane & Edson.
Mr. Dwyer also presently serves as a director of ILM 2, ILM I Lease  Corporation
and ILM II Lease Corporation. Mr. Dwyer has written several books on real estate
financing  and  taught  Real  Estate  Planning  as an Adjunct  Professor  at the
Georgetown University Law Center. Mr. Dwyer graduated from Georgetown University
and received his law degree from the Georgetown University Law Center.

    J. William  Sharman,  Jr. has served as a director of the Company since its
inception in 1989.  Mr.  Sharman is the Chairman of the Board and  President of
Lancaster  Hotel  Management,  L.C.,  a hotel  management  company,  and  Bayou
Equities,  Inc., a hotel development  company. Mr. Sharman served for ten years
as Chairman of the Board and  President of The  Lancaster  Group,  Inc., a real
estate  development firm based in Houston,  Texas,  which is the predecessor of
Lancaster  Hotel  Management,  L.C. and Bayou  Equities,  Inc.  Mr.  Sharman is
Chairman of Small Luxury Hotels,  Ltd. of the United Kingdom,  an international
hotel marketing and  reservations  firm. Mr. Sharman also presently serves as a
director  of ILM2  and  RPI.  He has a  Bachelor  of  Science  degree  in Civil
Engineering from the University of Notre Dame.

    Carl  J.  Schramm  was  appointed  to fill a  newly  created  seat on the
Company's  Board  of  Directors  as of  December  5,  1996.  Mr.  Schramm  is
President  of  Greenspring  Advisors,   Inc.,  a  consulting  and  investment
advisory  firm serving  clients in the managed  care,  health  insurance  and
health  information  industries.  From 1993 to 1995,  Mr.  Schramm  served as
Executive  Vice  President  of Fortis,  Inc.,  a  diversified  insurance  and
financial  services  company.   From  1987  through  1992,  Mr.  Schramm  was
President of the Health Insurance  Association of America, the national trade
association of commercial health  underwriters.  Mr. Schramm currently serves
on the boards of HCIA, Inc.,  LifeRate Systems,  Inc., the Rochdale Insurance
Group,  Physicians Health Corporation and Madison  Information  Technologies.
Mr.  Schramm holds a Ph.D. in Economics  from the University of Wisconsin and
received his J.D. from Georgetown University.

     Julien  G.  Redele'  was  appointed  to  fill a newly  created  seat on the
Company's  Board of Directors as of December 5, 1996.  Mr. Redele' is one of the
original  founders  of SFRE,  Inc.,  a Dutch owned real  estate  investment  and
development firm which has served since 1963 as advisor to Dutch  institutional,
corporate and  individual  investors  active in the United  States.  Mr. Redele'
serves  as a  director  of the  Island  Preservation  Partnership.  Mr.  Redele'
attended  Westersingel Business School,  Rotterdam,  where he studied economics,
law and finance.

    Bruce J. Rubin was named President and Chief  Executive  Officer of PWPI in
August 1996. Mr. Rubin joined  PaineWebber  Real Estate  Investment  Banking in
November 1995 as a Senior Vice  President.  Prior to joining  PaineWebber,  Mr.
Rubin was  employed by Kidder,  Peabody and served as  President  for KP Realty
Advisers,  Inc. Prior to his  association  with Kidder,  Mr. Rubin was a Senior
Vice  President and Director of Direct  Investments  at Smith Barney  Shearson.
Prior  thereto,  Mr. Rubin was a First Vice President and a real estate workout
specialist  at  Shearson  Lehman  Brothers.  Prior to joining  Shearson  Lehman
Brothers in 1989,  Mr. Rubin  practiced law in the Real Estate Group at Willkie
Farr & Gallagher.  Mr. Rubin is a graduate of Stanford  University and Stanford
Law School.

    Walter V. Arnold is a Senior Vice  President,  Chief  Financial  Officer and
Treasurer of the Company and Senior Vice President and Chief  Financial  Officer
of PWPI which he joined in October 1985.  Mr. Arnold joined PWI in 1983 with the
acquisition  of Rotan Mosle,  Inc.  where he had been First Vice  President  and
Controller  since 1978, and where he continued until joining PWPI. Mr. Arnold is
a Certified Public Accountant licensed in the state of Texas.

    James A. Snyder is a Senior Vice  President of the Company and a Senior Vice
President  of  PWPI.  Mr.  Snyder  re-joined  PWPI in July  1992  having  served
previously  as an officer of PWPI from July 1980 to August  1987.  From  January
1991 to July 1992, Mr. Snyder was with the Resolution Trust  Corporation,  where
he served as the Vice  President of Asset Sales prior to re-joining  PWPI.  From
February 1989 to October  1990,  he was  President of Kan Am Investors,  Inc., a
real estate investment company.  During the period August 1987 to February 1989,
Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast
Regional Management Inc., a real estate development company.

    C. David Carlson is a Vice  President of the Company and a Vice President of
PWPI which he joined in December  1995.  From 1987 through 1995, Mr. Carlson was
an officer in Belmont  Properties,  Inc., a Boston-based real estate investment,
development  and advisory  firm.  Mr.  Carlson  graduated from the University of
Minnesota  in 1977 and  received a Master of Science in Real Estate  Development
degree from the Massachusetts Institute of Technology in 1986.

    Dorothy F. Haughey is Secretary  of the  Company,  Assistant  Secretary of
PaineWebber  and Secretary of PWI and PWPI. Ms. Haughey joined  PaineWebber in
1962.

    (f) None of the  directors  and officers  was involved in legal  proceedings
which are  material to an  evaluation  of his or her ability or  integrity  as a
director or officer.

    (g)  Compliance  With  Exchange  Act  Filing  Requirements:  The  Securities
Exchange Act of 1934  requires the  officers and  directors of the Company,  and
persons who own more than ten percent of the Company's outstanding common stock,
to file  certain  reports  of  ownership  and  changes  in  ownership  with  the
Securities  and  Exchange  Commission.   Officers,   directors  and  ten-percent
beneficial  holders are required by SEC  regulations to furnish the Company with
copies of all Section 16(a) forms they file.

    Based  solely on its review of the copies of such forms  received by it, the
Company  believes  that,  during the year  ended  August  31,  1996,  all filing
requirements applicable to its officers and directors and ten-percent beneficial
holders were complied with.

Item 11.  Executive Compensation

    The Company's  Independent  Directors  each receive an annual fee of $12,000
and reimbursement for expenses incurred in attending meetings and as a result of
other work  performed  for the Company.  With the exception of Lawrence A. Cohen
beginning in August 1996,  the officers of the Company are also officers of PWPI
and receive  compensation from PWPI which indirectly  relates to services to the
Company. In addition, the Company is required to pay certain fees to the Advisor
as described in Item 13.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

    (a) As of the date  hereof,  no  person  of  record  owns or is known by the
Registrant to own beneficially more than five percent of the outstanding  shares
of common stock of the Company.

    (b) The  Directors  and  officers  of the  Company do not have any direct or
indirect  ownership  of  shares  of the  Company's  common  stock as of the date
hereof.

    (c) There  exists no  arrangement,  known to the Company,  the  operation of
which may at a subsequent date result in a change in control of the Company.

Item 13.  Certain Relationships and  Related Transactions

      Subject to the supervision of the Company's Board of Directors, assistance
with the  management  of the business of the Company is provided by  PaineWebber
ILM Advisor,  L.P. (the "Advisor"),  a limited partnership comprised of ILM REIT
Advisor, Inc., a Virginia corporation, and Properties Associates, L.P. ("PA"), a
Virginia  limited  partnership.  ILM  REIT  Advisor,  Inc.  is  a  wholly  owned
subsidiary of PaineWebber  Properties  Incorporated  ("PWPI"). In addition,  the
limited  partners  and holders of certain  assignee  interests of PA are or have
been  officers  of  PWPI.  PWPI is a  wholly  owned  subsidiary  of  PaineWebber
Incorporated  ("PWI").  PWI is a wholly-owned  subsidiary of PaineWebber  Group,
Inc. ("PaineWebber").

      Under  the  Advisory  Agreement,   the  Advisor  has  specific  management
responsibilities;  to perform day-to-day operations of the Company and to act as
the investment advisor and consultant for the Company in connection with general
policy and investment decisions. The Advisor will receive an annual Base Fee and
an Incentive  Fee of 0.15% and 0.45%,  respectively,  of the Gross Assets of the
Company,  as defined,  as  compensation  for such  services.  Incentive Fees are
subordinated to shareholders' receipt of distributions of net cash sufficient to
provide a return equal to 10% per annum. The Advisor earned base management fees
totalling  $88,000  for the year ended  August 31,  1996.  Payment of  incentive
management  fees was suspended  effective  April 15, 1993 in conjunction  with a
reduction in the Company's quarterly dividend payments.

      For its services in finding and  recommending  investments,  PWPI received
mortgage  placement  fees  equal to 2% of the  capital  contributions.  Mortgage
placement  fees  totalling  $1,504,000  were earned by PWPI during the Company's
investment  acquisition period. Such fees have been capitalized and are included
in  the  cost  of  the  operating  investment  properties  on  the  accompanying
consolidated balance sheets. For its administrative services with respect to all
loans,  PWPI received loan servicing fees equal to 1% of capital  contributions.
Loan servicing fees totalling  $752,010 were earned by PWPI during the Company's
investment  acquisition  period.  Such fees have also been  capitalized  and are
included in the cost of the operating investment  properties on the accompanying
consolidated balance sheets.

      In connection  with the  construction of Senior Housing  Facilities,  PWPI
received a fee,  paid directly by AHC,  equal to 1% of the  principal  amount of
each construction loan for administering construction loans made by the Company.
Such fees received by PWPI  totalled  $431,000  during the Company's  investment
acquisition period.

      The Advisor  will be entitled to receive 1% of  Disposition  Proceeds,  as
defined,  until the  shareholders  have received  dividends of Net Cash equal to
their Adjusted Capital Investments, as defined, plus a 12% non-compounded annual
return  on  their  Adjusted  Capital   Investments;   all  Disposition  Proceeds
thereafter  until the Advisor has  received an  aggregate  of 5% of  Disposition
Proceeds; and, thereafter, 5% of Disposition Proceeds.

      The Advisor and its affiliates  are  reimbursed for their direct  expenses
relating to the offering of Shares,  the  administration  of the Company and the
acquisition and operations of the Company's real estate investments.

      An affiliate of the Advisor performs certain accounting,  tax preparation,
securities law compliance and investor communications and relations services for
the Company.  Total costs incurred by this affiliate in providing these services
are allocated among several entities, including the Company. Included in general
and administrative expenses on the accompanying statement of income for the year
ended August 31, 1996 is $142,000, representing reimbursements to this affiliate
for providing such services to the Company.

      Mitchell Hutchins  Institutional  Investors,  Inc.  ("Mitchell  Hutchins")
provides cash  management  services  with respect to the Company's  cash assets.
Mitchell Hutchins is a subsidiary of Mitchell  Hutchins Asset Management,  Inc.,
an independently  operated  subsidiary of PaineWebber.  Mitchell Hutchins earned
$13,000  (included  in general and  administrative  expenses)  for  managing the
Company's cash assets during fiscal 1996. Fees charged by Mitchell  Hutchins are
based on a percentage of invested cash reserves  which varies based on the total
amount of invested cash which Mitchell Hutchins manages on behalf of PWPI.





<PAGE>






                                   PART IV



Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K

    (a)    The following documents are filed as part of this report:

           (1) and (2)  Financial Statements and Schedules:

                   The  response to this  portion of Item 14 is  submitted  as a
                   separate  section  of this  report.  See  Index to  Financial
                   Statements and Financial Statement Schedules at page F-1.

           (3)     Exhibits:

                   The exhibits listed on the accompanying  index to exhibits at
                   page IV-3 are filed as part of this Report.

    (b)    The  Company  filed a Current  Report on Form 8-K dated July 29, 1996
           reporting the termination by ILM I Lease  Corporation of the property
           management  agreement  with Angeles  Housing  Concepts,  Inc. and the
           retention of Capital  Senior  Management  2, Inc. as the new property
           manager.

    (c)    Exhibits:

                   See (a)(3) above.

    (d)    Financial Statement Schedules:

                   The  response to this  portion of Item 14 is  submitted  as a
                   separate  section  of this  report.  See  Index to  Financial
                   Statements and Financial Statement Schedules at page F-1.


<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.


                                         PAINEWEBBER INDEPENDENT
                                         LIVING MORTGAGE FUND, INC.



                                          By: /s/ Lawrence A. Cohen
                                          -------------------------
                                             Lawrence A. Cohen
                                             President and Chief Executive
                                             Officer


                                          By: /s/ Walter V. Arnold
                                          ------------------------
                                             Walter V. Arnold
                                             Senior Vice President and
                                             Chief Financial Officer
                                             (additionally functioning as
                                             chief accounting officer)

Dated:  December 13, 1996

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 Company in the
capacity and on the dates indicated.


By:/s/ Lawrence A. Cohen                        Date:December 13, 1996
   ------------------------------                    -----------------
   Lawrence A. Cohen
   Director


By:/s/ Jeffry R. Dwyer                          Date:December 13, 1996
   ------------------------------                    -----------------
   Jeffry R. Dwyer
   Director


By:/s/ J. William Sharman, Jr.                  Date:December 13, 1996
   ------------------------------                    -----------------
   J. William Sharman, Jr.
   Director


By:                                             Date:December 13, 1996
  ------------------------------                     -----------------
   Carl J. Schramm
   Director


By:                                             Date:December 13, 1996
  ------------------------------                     -----------------
   Julien G. Redele'
   Director



<PAGE>


                          ANNUAL REPORT ON FORM 10-K
                                Item 14(a)(3)

              PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.


                              INDEX TO EXHIBITS

                                                        Page Number in the
Exhibit No.        Description of Document              Report or Other
                                                        Reference
----------------   ---------------------------------    -----------------------

(3) and (4)        Prospectus  of  the   Registrant     Filed     with     the
                   dated   June   9,    1989,    as     Commission    pursuant
                   supplemented.                        to  Rule   424(c)  and
                                                        incorporated    herein
                                                        by reference.

(10)               Material  contracts   previously     Filed     with     the
                   filed     as     exhibits     to     Commission    pursuant
                   registration    statements   and     to   Section   13   or
                   amendments    thereto   of   the     15(d)      of      the
                   registrant   together  with  all     Securities    Exchange
                   such    contracts    filed    as     Act   of   1934    and
                   exhibits  of  previously   filed     incorporated    herein
                   Forms  8-K and  Forms  10-K  are     by reference.
                   hereby  incorporated  herein  by
                   reference.

                   Contracts   regarding  retention     Filed  as  Exhibits  1
                   by ILM I  Lease  Corporation  of     and 2 to  the  Current
                   Capital  Senior   Management  2,     Report   on  Form  8-K
                   Inc., as property manager.           dated  July  29,  1996
                                                        and       incorporated
                                                        herein by reference.


(13)               Annual Reports to Stockholders       No Annual  Report  for
                                                        the year ended  August
                                                        31,   1996   has  been
                                                        sent       to      the
                                                        Stockholders.       An
                                                        Annual  Report will be
                                                        sent       to      the
                                                        Stockholders
                                                        subsequent   to   this
                                                        filing.

(27)               Financial Data Schedule              Filed   as  the   last
                                                        page     of      EDGAR
                                                        submission   following
                                                        the          Financial
                                                        Statements         and
                                                        Financial    Statement
                                                        Schedule  required  by
                                                        Item 14.


<PAGE>


                          ANNUAL REPORT ON FORM 10-K
                       Item 14(a)(1) and (2) and 14(d)

              PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.

       INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES


                                                                      Reference

PaineWebber Independent Living Mortgage Fund, Inc.:

   Report of independent auditors                                          F-2

   Consolidated balance sheets as of August 31, 1996 and 1995              F-3

   Consolidated  statements  of income for the years  ended  
     August 31,  1996, 1995 and 1994                                       F-4

   Consolidated  statements of changes in  shareholders'  equity for
      the years ended August 31, 1996, 1995 and 1994                       F-5

   Consolidated  statements of cash flows for the years ended
      August 31, 1996, 1995 and 1994                                       F-6

   Notes to consolidated financial statements                              F-7

   Schedule III - Real Estate and Accumulated Depreciation                F-18




   Other  schedules  have been  omitted  since the required  information  is not
present or not  present  in amounts  sufficient  to  require  submission  of the
schedule,  or because the information  required is included in the  consolidated
financial statements, including the notes thereto.



<PAGE>


                        REPORT OF INDEPENDENT AUDITORS



The Shareholders of
PaineWebber Independent Living Mortgage Fund, Inc.:

     We have audited the accompanying consolidated balance sheets of PaineWebber
Independent  Living  Mortgage Fund, Inc. as of August 31, 1996 and 1995, and the
related consolidated  statements of income, changes in shareholders' equity, and
cash flows for each of the three years in the period ended August 31, 1996.  Our
audits also included the  financial  statement  schedule  listed in the Index at
Item 14(a).  These financial  statements and schedule are the  responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly, in all material respects, the consolidated financial position of
PaineWebber  Independent Living Mortgage Fund, Inc. at August 31, 1996 and 1995,
and the  consolidated  results of its  operations and its cash flows for each of
the three years in the period ended August 31, 1996 in conformity with generally
accepted  accounting  principles.  Also, in our opinion,  the related  financial
statement  schedule,   when  considered  in  relation  to  the  basic  financial
statements  taken as a whole,  presents  fairly  in all  material  respects  the
information set forth therein.





                                                /s/ ERNST & YOUNG LLP
                                                ---------------------
                                                ERNST & YOUNG LLP







Boston, Massachusetts
December 10, 1996


<PAGE>


              PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.

                          CONSOLIDATED BALANCE SHEETS
                           August 31, 1996 and 1995
                   (In thousands, except per share amounts)

                                    ASSETS

                                                          1996          1995
                                                          ----          ----
Operating investment properties, at cost:
   Land                                               $   3,352    $    3,352
   Building and improvements                             40,310        40,128
   Furniture, fixtures and equipment                      4,948         4,948
                                                      ---------    ----------
                                                         48,610        48,428
   Less:  accumulated depreciation                      (11,048)       (9,532)
                                                      ---------    ----------
                                                         37,562        38,896

Cash and cash equivalents                                 3,010         5,006
Interest and other receivables                              399           187
Accounts receivable - related party                         348             -
Prepaid expenses and other assets                            11           122
Deferred rent receivable                                    123             -
                                                      ---------    ----------
                                                      $  41,453    $   44,211
                                                      =========    ==========

                     LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable - affiliates                         $      22    $      144
Accounts payable and accrued expenses                        63           850
                                                      ---------    ----------
      Total liabilities                                      85           994


Shareholders' equity:
  Common stock, $0.01 par value, 
   10,000,000 shares authorized,
   7,520,100 shares issued and outstanding                   75            75
  Additional paid-in capital (net of offering costs)     65,711        65,711
  Accumulated deficit                                   (24,418)      (22,569)
                                                      ---------    ----------
      Total shareholders' equity                         41,368        43,217
                                                      ---------    ----------
                                                      $  41,453    $   44,211
                                                      =========    ==========















                            See accompanying notes.


<PAGE>


               PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.

                        CONSOLIDATED STATEMENTS OF INCOME
               For the years ended August 31, 1996, 1995 and 1994
                    (In thousands, except per share amounts)

                                              1996       1995         1994
                                              ----       ----         ----
Revenues:
   Rental and other income               $    6,328   $  16,239    $ 14,771
   Interest income earned
     on cash equivalents                        145         198          89
                                         ----------   ---------    --------
                                              6,473      16,437      14,860

Expenses:
   Property management fees                       -         890         813
   Property operating expenses                    -       8,626       8,326
   Depreciation and amortization              1,516       1,581       1,819
   Management and advisory fees                  88         202          94
   General and administrative                   391         382         404
   Professional fees                            339         633         476
   Director compensation                         24          24          24
                                         ----------   ---------    --------
                                              2,358      12,338      11,956
                                         -----------  ---------    --------
Net income                               $    4,115   $   4,099    $  2,904
                                         ==========   =========    ========

Earnings per share of common stock            $0.55       $0.54       $0.39
                                              =====       =====       =====

Cash dividends paid per share
  of common stock                             $0.70       $0.71       $0.40
                                              =====       =====       =====

    The above  earnings  and cash  dividends  paid per share of common stock are
based upon the 7,520,100 shares outstanding during each year.















                           See accompanying notes.


<PAGE>


               PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
               For the years ended August 31, 1996, 1995 and 1994
                    (In thousands, except per share amounts)


                          Common Stock    Additional
                         $.01 Par Value   Paid-in     Accumulated
                       Shares    Amount   Capital     Deficit         Total
                       ------    ------   -------     -------         -----

Shareholder's equity
at August 31, 1993    7,520,100   $   75  $ 65,711    $ (22,233)     $ 43,553

Cash dividends paid           -        -         -       (3,008)       (3,008)

Net income                    -        -         -        2,904         2,904
                     ----------   -------  -------    ----------    ----------

Shareholders' equity
at August 31, 1994   7,520,100        75    65,711      (22,337)       43,449

Cash dividends paid          -         -         -       (5,302)       (5,302)

Net income                   -         -         -        4,099         4,099

Adjustment to
eliminate
reporting lag
for combined
facilities'
operations (Note 4)          -        -          -          971           971
                   ------------    ----    -------    ---------     ---------

Shareholders' equity
at August 31, 1995    7,520,100      75     65,711      (22,569)       43,217

Cash dividends paid           -       -          -       (5,264)       (5,264)

Distribution of stock
in ILM I Lease
Corporation (Note 4)          -       -          -         (700)         (700)

Net income                    -       -          -        4,115         4,115
                 -------------- -------    -------    ---------     ---------

Shareholders' equity
at August 31, 1996   7,520,100   $  75     $65,711     $(24,418)    $  41,368
                  ============   =====     =======     ========-    =========






                           See accompanying notes.


<PAGE>


               PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
               For the years ended August 31, 1996, 1995 and 1994
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)


                                              1996       1995         1994
                                              ----       ----         ----
Cash flows from operating activities:
   Net income                                $4,115     $ 4,099      $  2,904
   Adjustments to reconcile net income to
     net cash provided by operating activities:
      Depreciation and amortization           1,516       1,581         1,819
      Changes in assets and liabilities:
        Interest and other receivables         (212)        116          (248)
        Accounts receivable - related party    (348)          -             -
        Prepaid expenses and other assets       111          51           (74)
        Deferred rent receivable               (123)          -             -
        Accounts payable - affiliates          (122)        437          (113)
        Accounts payable and accrued 
          expenses                             (787)        223        (1,204)
                                             -------    -------      --------
           Total adjustments                     35       2,408           180
           Net cash provided by operating
              activities                      4,150       6,507         3,084

Cash flows from investing activities:
   Initial investment in
       ILM I Lease Corporation                 (700)          -             -
   Net proceeds from full satisfaction of
     claims against Angeles Corporation
     and affiliates                               -       1,422             -
   Additions to operating investment
      properties                               (182)       (789)         (939)
                                             -------    -------      --------
           Net cash (used in) provided by
              investing activities             (882)        633          (939)
                                             -------    ------       --------

Cash flows from financing activities:
   Cash dividends paid to shareholders       (5,264)     (5,302)       (3,008)
                                             ------     -------      --------
           Net cash used in financing
               activities                    (5,264)     (5,302)       (3,008)

Net (decrease) increase in cash and
  cash equivalents                           (1,996)      1,838          (863)

Net increase in cash and cash equivalents
  to eliminate reporting lag of the
  combined facilities (Note 4)                    -         583             -

Cash and cash equivalents, 
     beginning of year                        5,006       2,585         3,448
                                             ------    --------      --------

Cash and cash equivalents, end of year       $3,010    $  5,006      $  2,585
                                             ======    ========      ========

Cash paid for state income taxes             $    3    $      3      $      3
                                             ======    =======       ========


                           See accompanying notes.


<PAGE>


              PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
                  Notes to Consolidated Financial Statements


1.  Nature of Operations and Basis of Presentation

      PaineWebber  Independent  Living  Mortgage Fund,  Inc. (the "Company") was
   organized  as a  corporation  on March 6, 1989 under the laws of the State of
   Virginia.  On June 21, 1989 the Company  commenced a public offering of up to
   10,000,000  shares  of its  common  stock  at $10 per  share,  pursuant  to a
   Registration  Statement  filed on Form S-11 under the  Securities Act of 1933
   (Registration Statement No. 33-27653). The public offering terminated on July
   21,  1989 with a total of  7,520,100  shares  issued.  The  Company  received
   capital contributions of $75,201,000,  of which $201,000 represented the sale
   of 20,100 shares to an affiliate,  Paine Webber Group, Inc.  ("PaineWebber").
   As of November 1, 1996, PaineWebber and its affiliates held 165,344 shares of
   the Company's  common stock.  The Company has elected to qualify and be taxed
   as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code of
   1986, as amended, for each taxable year of operations (see Note 2).

      The Company  originally  invested the net  proceeds of the initial  public
   offering in eight  participating  mortgage  loans  secured by Senior  Housing
   Facilities  located in seven different  states.  All of the loans made by the
   Company were  originally  with Angeles  Housing  Concepts,  Inc.  ("AHC"),  a
   company specializing in the development,  acquisition and operation of Senior
   Housing  Facilities.  The Company entered into an Exclusivity  Agreement with
   AHC and its parent company, Angeles Corporation  ("Angeles"),  which required
   AHC to provide the Company with  certain  specific  opportunities  to finance
   Senior Housing Facilities and set forth the terms and conditions of the loans
   which were made.  The loan  documents  under the  aforementioned  Exclusivity
   Agreement called for interest to be paid on construction loans at the rate of
   13% per annum during the construction period and for Base Interest to be paid
   on the permanent  loans at the rate of 10% per annum. In addition to the Base
   Interest,  Additional Interest was to be payable on the permanent loans in an
   amount equal to 10% of the Gross Revenues of the Senior  Housing  Facilities,
   as defined. Under the terms of the amended Exclusivity Agreement,  Additional
   Interest was to be no less than 3% of the aggregate  principal  amount of all
   permanent loans  outstanding for the entire term of the  investments.  In the
   aggregate,  the  properties  securing loans from the Company did not generate
   sufficient  cash flow to cover the debt service  payments owed to the Company
   under the amended terms of the Exclusivity Agreement.  To the extent that the
   properties  did not generate  sufficient  cash flow to make the full payments
   due  under the loan  documents,  the  shortfall  was  funded  by AHC  through
   December  1992.  The  source  of cash to make up  these  shortfalls  was from
   specified deficit reserve  accounts,  which had been funded from the proceeds
   of the mortgage loans, and from contributions by Angeles.

      During the quarter ended February 28, 1993,  Angeles announced that it was
   experiencing  liquidity  problems  that resulted in the inability to meet its
   obligations. Subsequent to such announcements, AHC defaulted on the regularly
   scheduled  mortgage  loan  payments  due to the  Company  on March  1,  1993.
   Subsequent  to March  1993,  payments  toward  the debt  service  owed on the
   Company's loans were limited to the net cash flow of the operating investment
   properties.  On May 3, 1993, Angeles filed for reorganization under a Chapter
   11 Federal Bankruptcy petition filed in the state of California.  AHC did not
   file for  reorganization.  The  Company  retained  special  counsel  and held
   extensive  discussions  with AHC  concerning the default status of its loans.
   During the fourth quarter of fiscal 1993, a non-binding  settlement agreement
   between the  Company,  AHC and Angeles was reached  whereby  ownership of the
   properties  would be  transferred  from AHC to the Company or its  designated
   affiliates. Under the terms of the Settlement Agreement, the Company released
   AHC and Angeles from certain  obligations under the loans. On April 27, 1994,
   each of the  properties  owned by AHC and securing the Loans was  transferred
   (collectively, "the Transfers") to newly-created special purpose corporations
   affiliated with the Company  (collectively,  "the Property  Companies").  The
   Transfers  had an effective  date of April 1, 1994 and were made  pursuant to
   the Settlement  Agreement  entered into on February 17, 1994 ("the Settlement
   Agreement") between the Company and AHC which had previously been approved by
   the  bankruptcy  court handling the  bankruptcy  case of Angeles.  All of the
   capital stock of each Property  Company was held by ILM Holding,  Inc.  ("ILM
   Holding"),  a Virginia  corporation.  In August  1995,  each of the  Property
   Companies  merged  into ILM  Holding.  As a result,  ownership  of the Senior
   Housing Facilities is now held by ILM Holding,  and the Property Companies no
   longer exist as separate legal entities.  The capital stock of ILM Holding is
   owned by the Company and PWP Holding,  Inc. ("PWP  Holding"),  a wholly-owned
   subsidiary of PaineWebber Properties  Incorporated ("PWPI"). PWPI is a wholly
   owned  subsidiary  of  PaineWebber  Incorporated,  which  is a  wholly  owned
   subsidiary of PaineWebber Group, Inc. ("PaineWebber").

      The Company  holds  substantially  all of the  economic  ownership  in ILM
   Holding,  while PWP Holding  holds  voting  control.  ILM Holding  issued 100
   shares of Series A  Preferred  Stock to the  Company  in return for a capital
   contribution  in the amount of $693,000  and issued  10,000  shares of Common
   Stock to PWP  Holding in return for a capital  contribution  in the amount of
   $7,000.  The holders of the Series A Preferred Stock are entitled to one vote
   for each share of  Preferred  Stock  held.  In  addition,  the holders of the
   Series A Preferred Stock are entitled to receive, when and if declared by the
   Board of Directors,  dividends and distributions in an aggregate amount equal
   to  1%  of  total  amount  of  dividends  and   distributions   made  to  all
   shareholders.  The holders of the Common  Stock are  entitled to one vote for
   each share of Common Stock held. The holders of the Common Stock are entitled
   to receive,  when and if declared by the Board of  Directors,  dividends  and
   distributions  in an  aggregate  amount  equal to 99% of the total  amount of
   dividends and distributions  made to all shareholders.  As part of the fiscal
   1994 settlement  agreement with AHC, ILM Holding retained AHC as the property
   manager for all of the Senior Housing  Facilities  pursuant to the terms of a
   management  agreement.  As  discussed  further  in  Note  5,  the  management
   agreement with AHC was  terminated in July 1996.  Subsequent to the effective
   date of the  Settlement  Agreement  with  AHC,  management  investigated  and
   evaluated  the  available  options  for  structuring  the  ownership  of  the
   properties  in  order to  maximize  the  potential  returns  to the  existing
   shareholders  while  maintaining the Company's  qualification as a REIT under
   the Internal  Revenue  Code (see Note 2). As discussed  further in Note 4, on
   September  12,  1994  the  Company  formed  a new  subsidiary,  ILM  I  Lease
   Corporation,  for the purpose of operating the Senior Housing Facilities. The
   Senior Housing  Facilities were leased to ILM I Lease  Corporation  effective
   September  1,  1995  (see  Note  4 for a  description  of  the  master  lease
   agreement).

      The  Company  had  accounted  for its  investments  in  mortgage  loans as
    investments in acquisition  and  construction  loans from inception  through
    fiscal 1994 under the equity method because the loans met certain accounting
    criteria  which  require  that  participating  mortgage  loans with  certain
    characteristics be accounted for as joint ventures. Such accounting criteria
    are meant to apply to lending  arrangements  which have essentially the same
    risks and potential rewards for the lender as would exist in a joint venture
    partnership.  Subsequent to the transfer of ownership of the Senior  Housing
    Facilities from AHC to ILM Holding and the initiation of the plans to master
    lease the properties to a shareholder owned operating company, management of
    the  Company  was  deemed to have  significant  control  over the  operating
    investment  properties.  As a result,  the  financial  position,  results of
    operations and cash flows of ILM Holding,  which has ownership  title to the
    properties, are presented on a consolidated basis with the Company beginning
    in fiscal 1995. The fiscal 1994 financial  statements  have been restated to
    present the combined  Facilities  on a  consolidated  basis in order for the
    statements of income to be comparable.  Such restatement does not affect the
    net income or net  shareholders'  equity amounts  previously  reported.  All
    material  intercompany  balances and  transactions  have been  eliminated in
    consolidation.  The  Company's  policy  had been to record its equity in the
    earnings or losses of the properties  based on financial  information of the
    properties  which was two  months in arrears  to that of the  Company.  As a
    result of the restructuring of the property  ownership  discussed above, the
    Company eliminated this reporting lag as of the end of fiscal 1995 (see Note
    4).

2.  Use of Estimates and Summary of Significant Accounting Policies

      The  accompanying  financial  statements have been prepared on the accrual
    basis  of  accounting  in  accordance  with  generally  accepted  accounting
    principles which requires  management to make estimates and assumptions that
    affect the reported  amounts of assets and  liabilities  and  disclosures of
    contingent  assets  and  liabilities  as of  August  31,  1996  and 1995 and
    revenues and expenses for each of the three years in the period ended August
    31, 1996.  Actual  results could differ from the  estimates and  assumptions
    used.



<PAGE>


      The Company's significant accounting policies are summarized as follows:

    A. BASIS OF PRESENTATION

       The operating  cycle in the real estate  industry is longer than one year
       and  the  distinction  between  current  and  non-current  is  of  little
       relevance.   Accordingly,   the  accompanying   consolidated  balance  is
       presented in an unclassified format.

    B.  INCOME TAXES

       The  Company  has  elected  to qualify  and to be taxed as a Real  Estate
       Investment  Trust  ("REIT")  under the Internal  Revenue Code of 1986, as
       amended,  for each taxable year of operations.  As a REIT, the Company is
       allowed a deduction for the amount of dividends paid to its shareholders,
       thereby effectively  subjecting the distributed net taxable income of the
       Company  to  taxation  at  the  shareholder   level  only,   provided  it
       distributes  at least 95% of its taxable  income and meets  certain other
       requirements  for  qualifying  as a  real  estate  investment  trust.  In
       connection  with  the  settlement  agreement  described  in Note  1,  the
       Company,  through  its  consolidated  affiliate,  obtained  title  to the
       properties securing its mortgage loan investments. To retain REIT status,
       the Company  must ensure that 75% of its annual  gross income is received
       from qualified sources. Under the original investment structure, interest
       income from the  Company's  mortgage  loans was a qualified  source.  The
       properties  that are now owned by an  affiliate of the Company are Senior
       Housing  Facilities  that  provide  tenants with more  services,  such as
       meals, activities, assisted living, etc., than are customary for ordinary
       residential apartment  properties.  As a result, a significant portion of
       the rents paid by the tenants  includes income for the increased level of
       services  received by them.  Consequently,  the rents paid by the tenants
       likely would not be qualified  rents for REIT  qualification  purposes if
       received directly by the Company. Therefore, if the Company received such
       rents  directly,  it could  lose  REIT  status  and be taxed as a regular
       corporation.  After extensive review,  the Board of Directors  determined
       that it  would  be in the  best  interests  of the  shareholders  for the
       Company  to retain  REIT  status  and master  lease the  properties  to a
       shareholder-owned  operating company.  As discussed further in Note 4, on
       September  12,  1994 the  Company  formed a new  subsidiary,  ILM I Lease
       Corporation,  for the purpose of operating the Senior Housing Facilities.
       The Senior  Housing  Facilities  were  leased to ILM I Lease  Corporation
       effective  September 1, 1995 (see Note 4 for a description  of the master
       lease agreement).

       The assumption of ownership of the properties through ILM Holding,  which
       is presently a regular C corporation for tax purposes,  has resulted in a
       possible  future tax  liability  which would be payable upon the ultimate
       sale of the properties (the "built-in gain tax").  The amount of such tax
       would be  calculated  based on the lesser of the total net gain  realized
       from the sale  transaction or the portion of the net gain realized upon a
       final  sale  which  is  attributable  to  the  period  during  which  the
       properties  were  held by in a C  corporation.  The  final  phase  of the
       Company's restructuring plans involves the conversion of ILM Holding to a
       REIT for tax purposes.  Certain changes to the ownership structure of ILM
       Holding which are necessary in order for ILM Holding to qualify as a REIT
       under the  Internal  Revenue Code are expected to be made in time for ILM
       Holding  to elect  REIT  status  in  conjunction  with the  filing of its
       calendar 1996 federal tax return. Any future appreciation in the value of
       the Senior Housing Facilities subsequent to the conversion of ILM Holding
       to a REIT would not be subject to the  built-in  gain tax.  The  built-in
       gain tax would most likely not be incurred if the  properties  were to be
       held for a period of at least 10 years from the date of the conversion of
       ILM Holding to a REIT.  However,  since the end of the Company's original
       anticipated  holding period is less than 4 years away, the properties are
       not  expected  to be held  for an  additional  10  years.  The  Board  of
       Directors may defer the Company's  scheduled  liquidation date, if in the
       opinion of a majority of the Directors,  the disposition of the Company's
       assets at such time would result in a material  under-realization  of the
       value of such assets; provided, however, that no such deferral may extend
       beyond December 31, 2004.  Based on management's  current estimate of the
       increase in the values of the  properties  which has occurred since April
       1994, as supported by independent  appraisals,  ILM Holding would incur a
       sizable tax if the properties were sold. Based on these current estimated
       market  values of the  operating  investment  properties,  a sale at such
       values prior to the end of the 10-year  holding  period could result in a
       built-in  gain tax of as much as $2.9  million.  As the  holder  of a 99%
       economic  interest in ILM Holding,  the burden of this  built-in gain tax
       would be primarily borne by the Company.

       The Company's  consolidated  affiliate,  ILM Holding, has incurred losses
       for tax purposes since inception.  Neither the Company nor ILM Holding is
       likely to be able to use these losses to offset  future tax  liabilities.
       Accordingly,  no income tax benefit is  reflected  in these  consolidated
       financial statements.

       The  Company  reports on a calendar  year basis for income tax  purposes.
       During calendar 1995, the Company distributed $0.78 per share in cash and
       $0.15 per share in shares of ILM I Lease  Corporation.  The tax status of
       these dividends amounted to an ordinary taxable dividend of approximately
       $0.64 per share and a tax free return of capital of  approximately  $0.29
       per share. The Company anticipates that all distributions during calendar
       1996 will be ordinary taxable dividends.

    C.  CASH AND CASH EQUIVALENTS

        For purposes of reporting cash flows, cash and cash equivalents  include
        all highly liquid  investments  with  original  maturities of 90 days or
        less.

    D.  OPERATING INVESTMENT PROPERTIES

        Operating  investment  properties  are  carried  at the  lower  of cost,
        reduced by accumulated  depreciation,  or net realizable  value. The net
        realizable value of a property held for long-term investment purposes is
        measured  by  the  recoverability  of  the  owner's  investment  through
        expected  future cash flows on an undiscounted  basis,  which may exceed
        the  property's  current  market value.  The net  realizable  value of a
        property  held  for sale  approximates  its  current  market  value,  as
        determined  on a  discounted  basis.  None of the  operating  investment
        properties   were  held  for  sale  as  of  August  31,  1996  or  1995.
        Depreciation  expense is  provided  on a  straight-line  basis  using an
        estimated useful life of 40 years for the buildings and improvements and
        5 years for the furniture, fixtures and equipment.

        The Company has reviewed FAS No. 121,  "Accounting for the Impairment of
        Long-Lived Assets and for Long-Lived Assets To Be Disposed Of," which is
        effective for financial  statements for years  beginning  after December
        15, 1995, and believes this new  pronouncement  will not have a material
        effect on the Company's financial statements.

    E.  RENTAL REVENUES

        Rental revenues on the accompanying income statements reflect the rental
        income received by the Company's consolidated affiliate, ILM Holding. In
        fiscal 1995 and 1994 this rental income consisted of payments due on the
        individual tenant leases at the Senior Housing Facilities.  Units at the
        Facilities are generally  rented for terms of twelve months or less. The
        base rent charged  varies  depending  on the unit size,  with added fees
        collected  for more than one occupant  per unit and for assisted  living
        services. Included in the amount of base rent charged are certain meals,
        housekeeping,  medical and social services  provided to the residents of
        each Facility.  In fiscal 1996,  rental revenues consist of payments due
        from  ILM I Lease  Corporation  under  the  terms  of the  master  lease
        described  in Note 4.  Base  rental  income  under the  master  lease is
        recognized on a straight-line basis over the term of the lease. Deferred
        rent  receivable on the balance  sheet as of August 31, 1996  represents
        the difference between rental income on a straight-line basis and rental
        income received under the terms of the master lease.

    F.  OFFERING COSTS

        Offering costs consist primarily of selling  commissions and other costs
        such as printing and mailing  costs,  legal fees,  filing fees and other
        marketing  costs  associated  with  the  offering  of  shares.   Selling
        commissions  were equal to 8% of the gross  proceeds  raised through the
        public offering.  Commissions  totalling  $6,000,000 were paid to PWI in
        connection with the sale of shares.  All of the offering costs are shown
        as a reduction of shareholders' equity.

    G.  FAIR VALUE DISCLOSURES

        FASB  Statement  No.  107,  "Disclosures  about Fair Value of  Financial
        Instruments" ("SFAS 107"), requires disclosure of fair value information
        about  financial  instruments,  whether or not recognized in the balance
        sheet,  for which it is  practicable  to estimate  that value.  In cases
        where quoted market prices are not  available,  fair values are based on
        estimates  using present value or other valuation  techniques.  SFAS 107
        excludes certain financial instruments and all nonfinancial  instruments
        from its disclosure requirements.  Accordingly, the aggregate fair value
        amounts presented do not represent the underlying value of the Company.

        The  following  methods  and  assumptions  were used by the  Company  in
        estimating its fair value disclosures for financial instruments:

        Cash and cash  equivalents:  The carrying amount reported on the balance
        sheet for cash and cash  equivalents  approximates its fair value due to
        the short-term maturities of such instruments.

        Accounts receivable - related party: The carrying amount reported on the
        balance sheet for accounts  receivable - related party  approximates its
        fair value due to the short-term maturity of such instrument.

3.  The Advisory Agreement and Related Party Transactions

       Subject  to  the   supervision  of  the  Company's  Board  of  Directors,
    assistance   in  managing  the  business  of  the  Company  is  provided  by
    PaineWebber  ILM  Advisor,  L.P.  (the  "Advisor"),  a  limited  partnership
    comprised of ILM REIT Advisor, Inc., a Virginia corporation,  and Properties
    Associates,  L.P. ("PA"), a Virginia limited partnership.  ILM REIT Advisor,
    Inc. is a wholly owned  subsidiary of  PaineWebber  Properties  Incorporated
    ("PWPI").  In  addition,  the  limited  partners  and  holders  of  assignee
    interests  of PA are or have been  officers of PWPI.  PWPI is a wholly owned
    subsidiary  of  PaineWebber  Incorporated  ("PWI").  PWI is a  wholly  owned
    subsidiary of PaineWebber Group, Inc. ("PaineWebber").

       The Advisor and its affiliates  receive fees and compensation  determined
    on an agreed-upon  basis, in consideration of various services  performed in
    connection  with the sale of the shares,  the  management of the Company and
    the  acquisition,  management and disposition of the Company's  investments.
    The type of  compensation  to be paid by the  Company to the Advisor and its
    affiliates under the terms of the Advisory Agreement is as follows.

    (i)Under  the  Advisory  Agreement,  the  Advisor  has  specific  management
       responsibilities;  to perform day-to-day operations of the Company and to
       act  as  the  investment  advisor  and  consultant  for  the  Company  in
       connection with general policy and investment decisions. The Advisor will
       receive  an annual  Base Fee and an  Incentive  Fee of 0.15%  and  0.45%,
       respectively,  of  the  Gross  Assets  of the  Company,  as  defined,  as
       compensation  for  such  services.  Incentive  Fees are  subordinated  to
       shareholders'  receipt of distributions of net cash sufficient to provide
       a return equal to 10% per annum.  The Advisor earned base management fees
       totalling  $88,000,  $89,000 and  $94,000 for the years ended  August 31,
       1996, 1995 and 1994,  respectively.  Payment of incentive management fees
       was suspended effective April 15, 1993 in conjunction with a reduction in
       the Company's quarterly dividend payments.

    (ii) For its services in finding and recommending investments, PWPI received
       mortgage  placement  fees  equal  to 2%  of  the  capital  contributions.
       Mortgage  placement fees totalling  $1,504,000 were earned by PWPI during
       the  Company's  investment   acquisition  period.  Such  fees  have  been
       capitalized  and are  included  in the cost of the  operating  investment
       properties on the accompanying consolidated balance sheet.

    (iii) For its  administrative  services  with  respect  to all  loans,  PWPI
       received loan servicing fees equal to 1% of capital  contributions.  Loan
       servicing  fees  totalling  $752,010  were  earned  by  PWPI  during  the
       Company's investment  acquisition period. Such fees have been capitalized
       and are included in the cost of the  operating  investment  properties on
       the accompanying consolidated balance sheet.
    (iv) In connection with the construction of Senior Housing Facilities,  PWPI
       received a fee, paid directly by AHC, equal to 1% of the principal amount
       of each construction loan for  administering  construction  loans made by
       the Company.  Such fees  received by PWPI  totalled  $431,000  during the
       Company's investment acquisition period.

    (v)The Advisor will be entitled to receive 1% of  Disposition  Proceeds,  as
       defined, until the shareholders have received dividends of Net Cash equal
       to  their  Adjusted  Capital   Investments,   as  defined,   plus  a  12%
       non-compounded  annual return on their Adjusted Capital Investments,  all
       Disposition  Proceeds  thereafter  until  the  Advisor  has  received  an
       aggregate  of  5%  of  Disposition  Proceeds;  and,  thereafter,   5%  of
       Disposition Proceeds.

       Included in  management  and advisory  fees for the year ended August 31,
    1995 are  advisory  fees of $114,000  earned by an affiliate of PWPI for its
    administration and supervision of the day-to-day  operations of ILM Holding.
    Such fees were equal to 0.5% of the Gross  Operating  Revenues of the Senior
    Housing  Facilities.  These  advisory  fees  were no longer  charged  to ILM
    Holding  effective  September  1, 1995 upon the  commencement  of the master
    lease described in Note 4.

       The Advisor and its affiliates  are reimbursed for their direct  expenses
    relating to the offering of Shares,  the  administration  of the Company and
    the  acquisition  and operations of the Company's  real estate  investments.
    Included  in  general  and  administrative   expenses  on  the  accompanying
    statements  of income for the years ended August 31, 1996,  1995 and 1994 is
    $142,000, $166,000 and $175,000,  respectively,  representing reimbursements
    to an affiliate of the Advisor for providing certain  financial,  accounting
    and investor communication services to the Company.

       Mitchell Hutchins  Institutional  Investors,  Inc. ("Mitchell  Hutchins")
    provides cash management services with respect to the Company's cash assets.
    Mitchell  Hutchins is a subsidiary of Mitchell  Hutchins  Asset  Management,
    Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins
    earned $13,000,  $4,000 and $7,000  (included in general and  administrative
    expenses)  for managing the Company's  cash assets during fiscal 1996,  1995
    and 1994, respectively.

       Accounts  receivable  -  related  party at  August  31,  1996  represents
    advances  made to ILM I Lease  Corporation  (see Note 4)  primarily  for the
    purchase of personal property to operate the Senior Housing Facilities.

       Accounts  payable - affiliates  at August 31, 1996 consists of management
    fees of $22,000  owed to the Advisor for the quarter  ended August 31, 1996.
    Accounts payable - affiliates at August 31, 1995 includes management fees of
    $22,000 owed to the Advisor for the quarter ended August 31, 1995, $4,000 of
    out-of-pocket expense  reimbursements payable to PWPI and $84,000 payable to
    an  affiliated  company,  PaineWebber  Independent  Living  Mortgage Inc. II
    (ILM2),  for  advances  made by ILM2 on behalf of the  Company  to the Villa
    Santa Barbara Senior Housing Facility.

4.    Operating Investment Properties Subject to Master Lease

        As of August 31, 1996 and 1995,  the Company,  through its  consolidated
    affiliate,  owned eight Senior Housing  Facilities.  The name,  location and
    size of the  properties  and the date  that  the  Company  made its  initial
    investment in such assets are as set forth below:

                                                   Rentable     Date of
            Name                    Location       Units        Investment (1)
            ----                    --------       -----        --------------

      Independence Village 
        of East Lansing         East Lansing, MI    159          6/29/89
      Independence Village 
        of Winston-Salem        Winston-Salem, NC   156          6/29/89
      Independence Village 
        of Raleigh              Raleigh, NC         163          4/29/91
      Independence Village 
        of Peoria               Peoria, IL          164          11/30/90
      Crown Pointe Apartments   Omaha, NE           133          2/14/90
      Sedgwick Plaza Apartments Wichita, KS         150          2/14/90
      West Shores               Hot Springs, AR     134          12/14/90
      Villa Santa Barbara  (2)  Santa Barbara, CA   123          7/13/92

     (1)Represents    the    date   of   the Company's  original  mortgage 
        loan to Angeles Housing  Concepts,  Inc. (see Note 1).
        

     (2)The acquisition of the California  Facility was financed  jointly by the
        Company  and  an  affiliated  entity,   PaineWebber  Independent  Living
        Mortgage  Inc.  II  ("ILM2").  All  amounts  generated  from Villa Santa
        Barbara are equitably apportioned between the Company, together with its
        consolidated  affiliate,   and  ILM2,  together  with  its  consolidated
        affiliate, generally 25% and 75%, respectively.

        The  cost  basis  of  the   operating   investment   properties  on  the
    accompanying  consolidated  balance sheets reflects the amounts funded under
    the Company's  participating  mortgage loans less certain guaranty  payments
    received from AHC in excess of the net cash flow of the Facilities under the
    terms  of the  Exclusivity  Agreement  with the  Company.  The  transfer  of
    ownership of the Senior Housing  Facilities from AHC in fiscal 1994 resulted
    in no  gain or loss  recognition  by the  Company  for  financial  reporting
    purposes.  As discussed in Note 1, in  accordance  with  generally  accepted
    accounting principles,  the Company had always accounted for its investments
    in acquisition and  construction  loans under the equity method,  as if such
    investments  were equity  interests  in a joint  venture.  Accordingly,  the
    carrying values of such  investments were reduced from inception by non-cash
    depreciation  charges  and by  payments  from AHC,  prior to the  default in
    fiscal 1993, in excess of the net cash flow  generated by the Senior Housing
    Facilities  received pursuant to the guaranty  agreement between the Company
    and AHC. As a result of this  accounting  treatment,  the carrying values of
    the Company's  investments had been reduced below  management's  estimate of
    the fair market value of the Senior  Housing  Facilities as of the effective
    date of the transfer of  ownership.  For federal  income tax  purposes,  the
    investments had always been carried at the  contractually  stated  principal
    balances of the participating  mortgage loans. For tax purposes only, a loss
    was  recognized  by the  Company  in 1994 in the  amount by which the stated
    principal  balances of the loans were reduced as of the date of the transfer
    of ownership.
<PAGE>
        As discussed in Note 1,  effective  April 1, 1994 each Property  Company
    acquired  the  respective  operating  property  subject  to, and assumed the
    obligations under, the mortgage loan payable to the Company, pursuant to the
    Settlement  Agreement  with  AHC.  The  principal  balance  on each loan was
    modified  to  reflect  the  estimated  fair value of the  related  operating
    property as of the date of the transfer of  ownership.  The  modified  loans
    require  interest-only  payments  on a monthly  basis at a rate of 9.5% from
    April 1, 1994  through  December 1, 1994,  11% for the period from January 1
    through  December 31, 1995,  12.5% for the period January 1 through December
    31, 1996,  13.5% for the period January 1 through December 31, 1997, 14% for
    the  period  January 1 through  December  31,  1998 and 14.5% for the period
    January 1, 1999  through  maturity.  In August  1995,  each of the  Property
    Companies was merged into ILM Holding. As a result,  ownership of the Senior
    Housing  Facilities,  as well as the obligation under the loans, is now held
    by ILM Holding, and the Property Companies no longer exist as separate legal
    entities.  Since  ILM  Holding  is  consolidated  with  the  Company  in the
    accompanying  financial statements,  the mortgage loans and related interest
    expense have been eliminated in consolidation.

        Subsequent to the effective date of the  Settlement  Agreement with AHC,
    in order to maximize  the  potential  returns to the  existing  shareholders
    while  maintaining the Company's  qualification as a REIT under the Internal
    Revenue Code, the Company formed a new corporation, ILM I Lease Corporation,
    for the purpose of operating the Senior Housing  Facilities  under the terms
    of a master lease agreement. As of August 31, 1995, ILM I Lease Corporation,
    which  is  taxable  as a  regular  C  Corporation  and not as a REIT,  was a
    wholly-owned  subsidiary  of the Company.  On  September 1, 1995,  after the
    Company received the required regulatory approval, it distributed all of the
    shares of capital stock of ILM I Lease  Corporation to the holders of record
    of the  Company's  common  stock.  One share of common  stock of ILM I Lease
    Corporation  was issued for each full share of the  Company's  common  stock
    held.  Prior  to the  distribution,  the  Company  capitalized  ILM I  Lease
    Corporation  with  $700,000 from its existing  cash  reserves,  which was an
    amount estimated to provide ILM I Lease  Corporation with necessary  working
    capital.  The master lease agreement,  which commenced on September 1, 1995,
    is initially between the Company's consolidated  affiliate,  ILM Holding, as
    owner of the properties and Lessor,  and ILM I Lease  Corporation as Lessee.
    The  master  lease is a  "triple-net"  lease  whereby  the  Lessee  pays all
    operating expenses, governmental taxes and assessments,  utility charges and
    insurance  premiums,  as  well as the  costs  of all  required  maintenance,
    personal  property  and  non-structural   repairs  in  connection  with  the
    operation of the Senior Housing  Facilities.  ILM Holding, as the Lessor, is
    responsible for all major capital improvements and structural repairs to the
    Senior  Housing  Facilities.  During the initial  term of the master  lease,
    which expires on December 31, 1999, ILM I Lease  Corporation is obligated to
    pay annual base rent for the use of all of the  Facilities  in the aggregate
    amount of  $5,886,000  for calendar year 1995  (prorated  based on the lease
    commencement date) and $6,364,800 for calendar year 1996 and each subsequent
    year. Beginning in January 1997 and for the remainder of the lease term, ILM
    I Lease  Corporation  will also be obligated  to pay variable  rent for each
    Facility. Such variable rent will be payable quarterly and will equal 40% of
    the excess,  if any, of the aggregate total revenues for the Facilities,  on
    an annualized basis, over $16,996,000.

        For fiscal 1996,  rental  income on the  accompanying  income  statement
    reflects  the  rental  payments  due  under the  terms of the  master  lease
    agreement.  For fiscal 1995 and fiscal  1994,  rental  income  reflects  the
    rental  payments  due  under  the  terms of the  individual  tenant  leases.
    Property  operating  expenses in the prior  periods  reflect the  day-to-day
    costs of operating the Facilities,  including the management fees payable to
    AHC, in addition to the real estate taxes  associated  with the ownership of
    the  operating  properties.  As noted  above,  under the terms of the master
    lease all such costs are now the responsibility of the Lessee.

        The  Company's  policy had been to record its equity in the  earnings or
    losses of the  properties  based on financial  information of the properties
    which was two months in arrears to that of the  Company.  As a result of the
    restructuring  of the  property  ownership  discussed in Note 1, the Company
    decided  to  eliminate  this  reporting  lag as of the end of  fiscal  1995.
    Summarized  operations of the eight operating investment  properties for the
    two-month period ended August 31, 1995, are as follows (in thousands):

                                            1995
                                            ----

     Revenues                           $  2,753

        Property management fees             152
        Property operating expenses        1,402
        Depreciation expense                 228
                                           1,782
                                        --------
     Net income                         $    971
                                        ========

     Earnings per share of 
        common stock                       $0.13
                                        ========

5.   Legal Proceedings and Contingencies

   Angeles Corporation Litigation
   ------------------------------

      Angeles had guaranteed  certain of the  obligations of AHC under the terms
   of the  Exclusivity  Agreement  described  in Note 1.  Under the terms of the
   Settlement  Agreement  discussed  in Note 1, the  Company  retained a general
   unsecured  claim  against  Angeles in the amount of $1,513,935 as part of the
   bankruptcy  proceedings,   but  waived  all  other  claims  against  Angeles,
   including any amounts of base and additional interest owed. In addition,  the
   Company maintained a claim for approximately $592,000 against an affiliate of
   Angeles which had made a separate guaranty to the Company. On March 17, 1995,
   the Bankruptcy Court handling the Angeles bankruptcy  proceedings  approved a
   final settlement of the Company's  outstanding claims against Angeles and its
   affiliates.  Pursuant to the terms of this settlement, the Company received a
   cash  payment of $1.5 million on April 14, 1995 in full  satisfaction  of the
   claims,  which  totalled  approximately  $2.1  million.  This amount,  net of
   certain related legal  expenses,  was recorded as a reduction in the carrying
   values of the operating investment properties.

   Termination of Management Contract with AHC
   -------------------------------------------

      On July 29, 1996,  ILM I Lease  Corporation  and ILM Holding,  Inc.  ("the
   Companies")  terminated the property  management  agreement with AHC covering
   the eight senior housing  facilities  leased by ILM I Lease  Corporation from
   ILM Holding, the Company's consolidated  affiliate.  The management agreement
   was terminated for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of
   the  agreement.   Simultaneously  with  the  termination  of  the  management
   agreement,  the Companies,  together with certain affiliated entities,  filed
   suit against AHC in the United States District Court for the Eastern District
   of Virginia for breach of contract, breach of fiduciary duty and fraud. ILM I
   Lease Corporation and ILM Holding allege that AHC willfully performed actions
   specifically  in violation of the management  agreement and that such actions
   caused damages to the Companies.  Due to the termination of the agreement for
   cause, no termination  fee was paid to AHC.  Subsequent to the termination of
   the management  agreement,  AHC filed for protection  under Chapter 11 of the
   U.S.  Bankruptcy  Code in its domestic  state of  California.  The filing was
   challenged by the Companies,  and the Bankruptcy  Court  dismissed AHC's case
   effective  October 15, 1996.  In November  1996,  AHC filed with the Virginia
   District  Court an Answer in  response  to the  litigation  initiated  by the
   Companies and a Counterclaim  against ILM Holding.  The Counterclaim  alleges
   that the  management  agreement  was  wrongfully  terminated  for  cause  and
   requests  damages  which  include the payment of the  termination  fee in the
   amount of  $1,250,000,  payment of  management  fees pursuant to the contract
   from August 1, 1996 through October 15, 1996, which is the earliest date that
   the  management  agreement  could have been  terminated  without  cause,  and
   recovery of attorney's  fees and  expenses.  PaineWebber  Independent  Living
   Mortgage Fund, Inc. guaranteed the payment of the termination fee at issue in
   these proceedings.  The Companies intend to diligently prosecute the case and
   to vigorously defend the  counterclaims  made by AHC. The eventual outcome of
   this  termination  dispute cannot  presently be determined.  Accordingly,  no
   provision for any liability which might result from the Company's guaranty of
   the  termination  fee  has  been  recorded  in  the  accompanying   financial
   statements.

      ILM I Lease  Corporation  has retained  Capital Senior  Management 2, Inc.
   ("Capital")  of Dallas,  Texas to be the new  manager  of the Senior  Housing
   Facilities  pursuant to a Management  Agreement  which  commenced on July 29,
   1996.  Under the terms of the Agreement,  Capital will earn a Base Management
   Fee  equal  to 4% of the  Gross  Operating  Revenues  of the  Senior  Housing
   Facilities,  as defined.  Capital  will also be eligible to earn an Incentive
   Management  Fee equal to 25% of the amount by which the  average  monthly Net
   Cash Flow of the Senior Housing Facilities,  as defined, for the twelve month
   period ending on the last day of each calendar month exceeds a specified Base
   Amount. Each August 31, beginning on August 31, 1997, the Base Amount will be
   increased  annually  based on the  percentage  increase in the Consumer Price
   Index.  PaineWebber Independent Living Mortgage Fund, Inc. has guaranteed the
   payment  of all  fees  due to  Capital  under  the  terms  of the  Management
   Agreement.


<PAGE>


   Shareholder Matters
   -------------------

      In November  1994,  a series of  purported  class  actions  (the "New York
   Limited Partnership  Actions") were filed in the United States District Court
   for the Southern District of New York concerning  PaineWebber  Incorporated's
   sale and  sponsorship  of various  limited  partnership  interests and common
   stock,  including the  securities  offered by the Company.  The lawsuits were
   brought  against  PaineWebber  Incorporated  and  Paine  Webber  Group,  Inc.
   (together, "PaineWebber"), among others, by allegedly dissatisfied investors.
   In March 1995,  after the  actions  were  consolidated  under the title In re
   PaineWebber  Limited  Partnership  Litigation,  the plaintiffs  amended their
   complaint to assert claims against a variety of other  defendants,  including
   PaineWebber Properties Incorporated ("PWPI"), an affiliate of PaineWebber and
   the parent company of the general  partner of the Advisor to the Company.  On
   May 30,  1995,  the court  certified  class  action  treatment  of the claims
   asserted in the litigation.

      The amended complaint in the New York Limited  Partnership Actions alleged
   that,  in  connection  with the sale of  common  stock  of the  Company,  the
   defendants (1) failed to provide  adequate  disclosure of the risks involved;
   (2) made  false  and  misleading  representations  about  the  safety  of the
   investments and the Company's anticipated  performance;  and (3) marketed the
   Company  to  investors  for whom  such  investments  were not  suitable.  The
   plaintiffs,  who  purported to be suing on behalf of all persons who invested
   in the Company  also  alleged that  following  the issuance of the  Company's
   stock,  the  defendants   misrepresented   financial  information  about  the
   Company's  value and  performance.  The amended  complaint  alleged  that the
   defendants  violated the Racketeer  Influenced and Corrupt  Organizations Act
   ("RICO") and the federal  securities laws. The plaintiffs sought  unspecified
   damages,  including  reimbursement  for  all  sums  invested  by  them in the
   Company's stock, as well as disgorgement of all fees and other income derived
   by PaineWebber  from the Company.  In addition,  the  plaintiffs  also sought
   treble damages under RICO.

      In January 1996, PaineWebber signed a memorandum of understanding with the
   plaintiffs  in the class action  outlining  the terms under which the parties
   have agreed to settle the case. Pursuant to that memorandum of understanding,
   PaineWebber  irrevocably deposited $125 million into an escrow fund under the
   supervision of the United States District Court for the Southern  District of
   New York to be used to resolve the litigation in accordance with a definitive
   settlement agreement and a plan of allocation.  On July 17, 1996, PaineWebber
   and the class plaintiffs  submitted a definitive  settlement  agreement which
   has been  preliminarily  approved by the court and  provides for the complete
   resolution of the class action litigation, including releases in favor of the
   Company and PWPI,  and the  allocation  of the $125 million  settlement  fund
   among investors in the various  partnerships  and REITs at issue in the case.
   As part of the settlement,  PaineWebber  also agreed to provide class members
   with certain  financial  guarantees  relating to some of the partnerships and
   REITs.  The  details  of the  settlement  are  described  in a notice  mailed
   directly to class members at the  direction of the court.  A final hearing on
   the fairness of the proposed  settlement is scheduled to continue in December
   1996.

      In February 1996,  approximately  150 plaintiffs  filed an action entitled
   Abbate v. PaineWebber Inc. in Sacramento,  California  Superior Court against
   PaineWebber  Incorporated  and various  affiliated  entities  concerning  the
   plaintiffs'  purchases of various  limited  partnership  investments and REIT
   stocks,  including those offered by the Company. The complaint alleges, among
   other things,  that PaineWebber and its related entities  committed fraud and
   misrepresentation  and  breached  fiduciary  duties  allegedly  owed  to  the
   plaintiffs by selling or promoting  limited  partnership and REIT investments
   that were  unsuitable for the  plaintiffs  and by  overstating  the benefits,
   understating  the risks and failing to state  material  facts  concerning the
   investments.  The complaint  seeks  compensatory  damages of $15 million plus
   punitive  damages.  In  September  1996,  the  court  dismissed  many  of the
   plaintiffs'   claims   as  barred  by   applicable   securities   arbitration
   regulations.

      In June  1996,  approximately  50  plaintiffs  filed  an  action  entitled
   Bandrowski v.  PaineWebber  Inc. in  Sacramento,  California  Superior  Court
   against  PaineWebber  Incorporated and various affiliated entities concerning
   the plaintiff's  purchases of various limited partnership  interests and REIT
   stocks,   including   those   offered  by  the  Company.   The  complaint  is
   substantially  similar to the complaint in the Abbate action described above,
   and seeks compensatory damages of $3.4 million plus punitive damages.

      In July 1996, approximately 15 plaintiffs filed an action entitled Barstad
   v.  PaineWebber  Inc. in Maricopa  County,  Arizona  Superior  Court  against
   PaineWebber  Incorporated  and various  affiliated  entities  concerning  the
   plaintiffs'  purchases  of various  limited  partnership  interests  and REIT
   stocks,   including   those   offered  by  the  Company.   The  complaint  is
   substantially  similar to the complaint in the Abbate action described above,
   and seeks compensatory damages of $752,000 plus punitive damages.

      With  respect to the  Abbate,  Bandrowski  and Barstad  actions  described
   above,  the defendants' time to move against or answer the complaints has not
   yet expired.  In all cases,  PaineWebber  intends to  vigorously  contest the
   allegations of the actions.  However, the eventual outcome of this litigation
   and the potential  impact,  if any, on the Company's  shareholders  cannot be
   determined at the present time. Mediation hearings on the Abbate,  Bandrowski
   and Barstad actions are currently scheduled to be held in December 1996.

      Under certain  limited  circumstances,  pursuant to the Advisor  Agreement
   with the Advisor and other contractual  obligations,  PaineWebber  affiliates
   could  be  entitled  to  indemnification  for  expenses  and  liabilities  in
   connection with the shareholder  litigation matters described above. However,
   PaineWebber  has agreed  not to seek  indemnification  for any  amounts it is
   required to pay in  connection  with the  settlement  of the New York Limited
   Partnership  Actions. At the present time, neither PaineWebber nor management
   can  estimate  the impact,  if any, of any of the  potential  indemnification
   claims on the Company's financial statements,  taken as a whole. Accordingly,
   no provision for any liability  which could result from the eventual  outcome
   of these matters has been made in the accompanying financial statements.

6.   Subsequent Events

      On  September  15,  1996,  the  Company's  Board of  Directors  declared a
   quarterly  dividend for the quarter  ended  August 31,  1996.  On October 15,
   1996, a dividend of $0.175 per share of common stock,  totalling  $1,316,000,
   was made to  shareholders of record as of September 30, 1996. On December 13,
   1996,  the Board of Directors  declared a quarterly  dividend for the quarter
   ended November 30, 1996. On January 15, 1997, a dividend of $0.1875 per share
   of common stock, totalling $1,410,000, will be made to shareholders of record
   as of January 2, 1997.


<PAGE>
<TABLE>
Schedule III - Real Estate and Accumulated Depreciation

                                      PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
                                     SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
                                                        August 31, 1996
                                                    (Amounts in thousands)
<CAPTION>

                                                 Costs
                                                Capitalized                                                            Life on Which
                                                 (Removed)                                                              Depreciation
                                 Initial Cost   Subsequent to  Gross Amount at Which Carried at                          in Latest
                                  TO ILM (2)   Acquisition              End of Year                                      Income
                                  Buildings &  Buildings &         Buildings &        Accumulated  Date of      Date     Statement
 Description Encumbrances(1) Land Improvements Improvements(3)Land Improvements Total Depreciation Construction Acquired is Computed
 ----------- --------------- ----- ----------- --------------- --- ------------  ---- ------------ ------------ -------- ----------
<S>          <C>              <C>  <C>         <C>             <C>    <C>        <C>       <C>         <C>          <C>      <C>
CONGREGATE CARE FACILITIES:

East Lansing,
  MI         $ 8,950         $ 422  $  9,251    $(2,881)      $  334  $ 6,458   $ 6,792   $ 1,849      1989     6/29/89  5-40 yrs.

Winston-Salem,
  NC           5,750           520     8,883     (3,881)         337    5,185     5,522     1,736      1989     6/29/89  5-40 yrs.

Raleigh,
  NC           8,350         1,021    10,992     (3,414)         741    7,858     8,599     1,832      1991     4/29/91  5-40 yrs.

Peoria,
  IL           8,350           524    10,867     (2,831)         426    8,134     8,560     1,793      1990     11/30/90 5-40 yrs.

Omaha,
  NE           8,200           430     8,092        521          447    8,596     9,043     1,793      1985     2/14/90  5-40 yrs.

Wichita,
  KS           8,350           388     5,381        174          367    5,576     5,943     1,279      1985     2/14/90  5-40 yrs.

Hot Springs,
  AR           5,350           290     3,187       (736)         301    2,440     2,741       543      1987     12/14/90 5-40 yrs.

Santa Barbara,
  CA          1,698            387     1,086        (63)         399    1,011     1,410       223      1979     7/13/92  5-40 yrs.
             ------         ------   -------    -------      -------   ------   -------   -------

             $54,998        $3,982  $ 57,739    $(13,111)    $ 3,352  $45,258   $48,610   $11,048
             =======        ======  ========    ========     =======  =======   ========  =======


(1)  Encumbrances   represent  first  mortgage  loans  between  ILM  Holding  as
     mortgagor and ILM as mortgagee.  Such loans are eliminated in consolidation
     in the accompanying financial statements (see Note 4).

(2)  Initial cost to ILM  represents  the aggregate  advances made by ILM on the
     loans secured by the Facilities which were made to AHC prior to the default
     and  foreclosure  actions  described  in Notes 1 and 4 to the  Consolidated
     Financial Statements.

(3)  Costs  removed  subsequent  to  acquisition  reflect the guaranty  payments
     received by ILM from AHC under the terms on the  Exclusivity  Agreement  as
     discussed  further  in  Notes  1  and  4  to  the  Consolidated   Financial
     Statements.

(4)  The  aggregate  cost of real  estate  owned at August 31,  1996 for Federal
     income tax purposes is approximately $55,969,000.




<PAGE>


Schedule III - Real Estate and Accumulated Depreciation (continued):   

               PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
              SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
                                 August 31, 1996
                             (Amounts in thousands)


(5)    Reconciliation of real estate owned:                              1996        1995         1994
                                                                         ----        ----         ----
      Balance at beginning of period                                  $ 48,428    $ 48,930      $ 47,991
        Acquisitions and improvements - 12 months ended 8/31/96            182           -             -
        Acquisitions and improvements - 12 months ended 6/30                 -         789           939
        Improvements - 2 months ended 8/31/95                                -         131             -
        Net proceeds from full satisfaction
          of claims against Angeles Corporation
          and affiliates                                                     -      (1,422)            -
                                                                      --------    --------      --------
      Balance at end of period                                        $ 48,610    $ 48,428      $ 48,930
                                                                      ========    ========      ========

(6)   Reconciliation of accumulated depreciation:

      Balance at beginning of period                                  $   9,532  $   7,723     $   5,908
        Depreciation expense - 12 months ended 8/31/96                    1,516          -             -
        Depreciation expense - 12 months ended 6/30                           -      1,581         1,815
        Depreciation expense - 2 months ended 8/31/95                         -        228             -
                                                                      ---------   --------      --------
      Balance at end of period                                        $  11,048   $  9,532      $  7,723
                                                                      =========   ========      ========

</TABLE>