**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**(MarkOne)**

 

| **ý** |   | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                         |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                              |
|       |   | **For the fiscal year ended December  31, 2002**                                                                                                                                                                                                                                                  |
|       |   |                                                                                                                                                                                                                                                                                              |
|       |   | **OR**                                                                                                                                                                                                                                                                                            |
|       |   |                                                                                                                                                                                                                                                                                              |
| **o**      |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                                                                              |
|       |   | **For the transition period  from                     to                     ** |
|       |   |                                                                                                                                                                                                                                                                                              |
|       |   | **Commission file number 0-20164**                                                                                                                                                                                                                                                                |

 

**Krupp Government Income Trust II**

(Exact name of registrantas specified in its charter)

 

| **Massachusetts**                                                             |   | **04-3073045**                     |
|-------------------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation or organization)               |   | (IRS Employer  Identification No.) |
|                                                                          |   |                               |
| **One Beacon Street, Boston, Massachusetts**                                  |   | **02108**                          |
| (Address of principal  executive offices)                                     |   | (Zip Code)                         |
|                                                                          |   |                               |
| (Registrant’s telephone  number, including area code) **(617) 523-0066** |

 

Securities registeredpursuant to Section 12(b) of the Act:

 
| **Title**                      |   | **Name of Exchange on which Registered** |
|--------------------------------|--------|------------------------------------------|
| Shares of Beneficial  Interest |   | None                                     |

 

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

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  ý   No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 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 informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o.

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2).

 

Yes  o   No  ý

 

Aggregate market value of voting securities held bynon-affiliates:  Not applicable.

 

Documents incorporated by reference: see Item 15

 

The exhibit index is located on pages 13-16.

 

 

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PART I

 

This Form 10-K containsforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934.  Actual results could differ materially fromthose projected in the forward-looking statements as a result of a number offactors, including those identified herein.

 
| ITEM 1. | BUSINESS |
|---------|----------|

 

Krupp Government Income Trust II (the “Trust”) is a Massachusettsbusiness trust that was formed on February 8, 1991 and is authorized to sell upto 25,000,000 shares of beneficial interest (the “Shares”).  Berkshire Realty Advisors LimitedPartnership acquired 10,000 of such Shares and 18,315,158 Shares were soldunder the Trust’s public offering for $365,686,058 net of purchase volumediscounts of $617,102.  On December 29,1994, Berkshire Mortgage Advisors Limited Partnership (the “Advisor”) acquiredBerkshire Realty Advisors Limited Partnership’s 10,000 Shares and assumed therole of the Advisor to the Trust.  Underthe Dividend Reinvestment Plan (“DRP”) of the Trust, 46,319 Shares were soldfor $880,061.  The remaining 6,628,523Shares are available for general Trust purposes.  The Trust has utilized the net proceeds from the public offeringand the DRP to acquire participating insured mortgages (“PIMs”), participatinginsured mortgage investments (“PIMIs”) and mortgage-backed securities (“MBS”).The Trust considers itself to be engaged in only one industry segment,investment in mortgages.

 

The Trust has elected to be treated as a real estate investment trust(“REIT”), under the Internal Revenue Code of 1986, as amended.  The Trust shall terminate on December 31,2030, unless earlier terminated by the affirmative vote of holders of amajority of the outstanding Shares entitled to vote thereon.  See Note A of the Notes to FinancialStatements included in Appendix A of this report on Form 10-K for additionalinformation.

 

An investment by the Trust in a PIM on a multi-family residentialproperty consists of (1) a MBS or an insured mortgage loan (the “guaranteed orinsured mortgage”) guaranteed or insured as to principal and basic interest and(2) a participating mortgage. Guaranteed or insured mortgages are issued ororiginated under or in connection with the housing programs of Fannie Mae orthe Federal Housing Administration (“FHA”) under the authority of theDepartment of Housing and Urban Development (“HUD”). PIMs provide the Trustwith monthly payments of principal and basic interest and may also provide forTrust participation in the current revenue stream and in the residual value, ifany, from a sale or other realization of the underlying property.  The participation rights to the Trust areconveyed through a subordinated promissory note and mortgage.  The participation features are neitherinsured nor guaranteed.

 

An investment by the Trust in a PIMI consists of (1) a MBS issued byFannie Mae and (2) an additional loan (“Additional Loan”) to the borrower inexcess of mortgage amounts guaranteed by Fannie Mae that increases the Trust’stotal financing with respect to that property. Additional Loans are collateralized by a subordinated mortgage on theunderlying property but are neither insured nor guaranteed.  Under the Additional Loans, the Trustreceives semi-annual interest payments and may provide additional interest inthe future, including participation in the net income and residual value, ifany, of the underlying property.

 

The Trust also has investments in MBS collateralized by single-familyand multi-family mortgage loans issued or originated by Fannie Mae, theGovernment National Mortgage Association (“GNMA”) or the Federal Home LoanMortgage Corporation (“FHLMC”).  FannieMae, GNMA and FHLMC guarantee the principal and interest of the Fannie Mae,GNMA and FHLMC MBS, respectively.

 

The Trust will distribute all proceeds from prepayments or otherrealizations of mortgage assets to investors either through quarterly dividendsor special dividends.

 

Although the Trust will terminate no later than December 31, 2030, thevalue of the PIMIs and PIMs may be realized by the Trust through repayment orsale as early as ten years from the closing dates of the permanent loans.  Should the Trust realize the value of all ofits other investments within that time frame, it may dissolve significantlyprior to December 31, 2030.

 

The Trust anticipatesthat there will be sufficient cash flow from the mortgages to meet cashrequirements.  To the extent that theTrust’s cash flow should be insufficient to meet the Trust’s operating expensesand liabilities, it will be necessary for the Trust to obtain additional fundsby liquidating its investment in one or more mortgages or by borrowing funds.The Trust may pledge mortgages as security for any permitted borrowing offunds.

 

The Trust may not borrow funds in connection with the acquisition ororigination of mortgages.  However, itmay borrow funds in order to meet working capital requirements of the Trust.  In this event, the Trust may borrow fundsfrom third parties on a short-term basis. The declaration of trust of the Trust (the “Declaration of Trust”)limits the amount that may 

 

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be borrowed by the Trust. Borrowing agreements between the Trust and a lender may also restrictthe amount of indebtedness that the Trust may incur.  The Declaration of Trust prohibits the Trust from issuing debtsecurities to institutional lenders and banks, and the Trust may not issue debtsecurities to the public except in certain limited circumstances.  The Trust, under some circumstances, mayborrow funds from the Advisor, a Trustee, or an affiliate of the Trust or aTrustee.  However, a majority of theindependent Trustees, not otherwise interested in such transaction, mustapprove the transaction as being fair, competitive and commercially reasonableand no less favorable to the Trust than loans between unaffiliated lenders andborrowers under the same circumstances. The Trust has not borrowed any funds in the past and does not intend todo so in the future.

 

The FHA coinsurance loan program under Section 221(d)(4) of theNational Housing Act provides for loans with 40-year terms. However, thisprogram allows for a call option at any time after ten years, upon one year’snotice.  The Fannie Mae DelegatedUnderwriting and Servicing Program provides for loans with seven, ten or 15year terms and an amortization period of 35 years.  The subordinated promissory notes and subordinated mortgages thatsecure the participation feature of the PIMs and the notes that evidence theAdditional Loans provide for acceleration of maturity at the earlier of thesale of the underlying property or the call date.

 

The Trust expects that, from time to time, it may realize the principaland participation in residual value, if any, of its mortgages beforematurity.  It is expected that themortgages will be repaid after a period of ownership of approximately ten yearsfrom the closing dates of the permanent loans. Realization of the value of the mortgages may, however, be made at anearlier or later date.

 

The Trust will not underwrite securities of other issuers, offersecurities in exchange for property or invest in securities of other issuersfor the purpose of exercising control and has not engaged in any of theseactivities in the past.  The Declarationof Trust does not permit the Trust to issue senior securities.  The Trust has not repurchased or reacquiredany of its Shares from shareholders in the past.  The Trust may not make loans to the Advisor, any Trustee, anyaffiliate of the Advisor or any Trustee or any other person, other thanmortgage investments of the type described above.

 

The Trust’s investments are not expected to be subject to seasonalfluctuations, although net income may vary somewhat from quarter to quarterbased upon the participation features of its investments. The requirements forcompliance with federal, state and local regulations to date have not had amaterial adverse effect upon the Trust’s operations, and the Trust anticipatesno material adverse effect in the future.

 

To qualify as a REIT for federal income tax purposes, the Trust made avalid election to be so treated and must continue to satisfy a range of complexrequirements including criteria related to its ownership structure, the natureof its assets, the sources of its income and the amount of its dividends toshareholders.  The Trust intends toqualify as a REIT in each year of operation; certain factors however, may havean adverse effect on the Trust’s REIT status. If, for any taxable year, theTrustees and the Advisor determine that any of the asset, income, or dividendcriteria are not likely to be satisfied, the Trust may be required to borrowfunds, dispose of mortgages or take other action to avoid the loss of its REITstatus.

 

Additionally, if the Trust does not qualify as a REIT for any taxableyear, it will be subject to federal income tax as if it were a corporation andthe shareholders will be taxed as shareholders of a corporation.  If the Trust were taxed as a corporation,the payment of such tax by the Trust would substantially reduce the fundsavailable for dividends to shareholders. To the extent that dividends had beenmade in anticipation of the Trust’s qualification as a REIT, the Trust might berequired to borrow additional funds or to liquidate certain of its investmentsin order to pay the applicable tax. Moreover, should the Trust’s election to betaxed as a REIT be terminated or voluntarily revoked, the Trust may not be ableto elect to be treated as a REIT for the following five-year period.

 

As of December 31, 2002, no personnel were directly employed by theTrust.

 
| ITEM 2. | PROPERTIES |
|---------|------------|

 

None.

 
| ITEM 3. | LEGAL PROCEEDINGS |
|---------|-------------------|

 

There are no material pending legal proceedings to which the Trust, anydirector, officer or affiliate of the Trust is a party to which would have amaterially adverse effect on the Trust. There are no material pending legal proceedings relating to any of the Trust’sinvestments.

 
| ITEM 4. | SUBMISSION OF MATTERS  TO A VOTE OF SECURITY HOLDERS |
|---------|------------------------------------------------------|

 

None.

 

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PART II

 
| ITEM 5. | MARKET FOR REGISTRANT’S  COMMON EQUITY AND RELATED STOCKHOLDER MATTERS |
|---------|-----------------------------------------------------------------------------|

 

Currently there is no established public trading market for the Shares.

 

The number of investors holding Shares as of December 31, 2002 wasapproximately 12,700.

 

The Trust has and intends to continue to declare and pay dividends on aquarterly basis.  The Trusteesestablished a dividend rate per Share per quarter of $.14 for the third andfourth quarter of 2002, $.24 for the first and second quarter of 2002 and $.24for each quarter of 2001.

 
| ITEM 6. | SELECTED FINANCIAL DATA |
|---------|-------------------------|

 

The following table sets forth selected financial information regardingthe Trust’s financial position and operating results. This information shouldbe read in conjunction with Management’s Discussion and Analysis of FinancialCondition and Results of Operations and the Financial Statements andSupplementary Data, which are included in Item 7 and Item 8, Appendix A of thisreport, respectively.

 
|                                |   | **(Amounts in thousands, except for per Share amounts)** |    |
|-------------------------------------|--------|----------------------------------------------------------|---------|
|                                |   | **2002**                                                 |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                |   |                                                     |    |   |   |   |   |   |   |   |   |
| Total revenues                      |   | $                                                        | 17,359  |   | $ | 25,330 |   | $ | 16,978 |   | $ | 19,613 |   | $ | 21,630 |   |
|                                |   |                                                     |    |   |   |   |   |   |   |   |   |
| Net income                          |   | $                                                        | 14,037  |   | $ | 22,141 |   | $ | 13,625 |   | $ | 14,974 |   | $ | 13,183 |   |
|                                |   |                                                     |    |   |   |   |   |   |   |   |   |
| Net income per Share                |   | $                                                        | .76     |   | $ | 1.21 |   | $ | .74 |   | $ | .82 |   | $ | .72 |   |
|                                |   |                                                     |    |   |   |   |   |   |   |   |   |
| Weighted average Shares outstanding |   | 18,371                                                   |    | 18,371 |   | 18,371 |   | 18,371 |   | 18,371 |   |
|                                |   |                                                     |    |   |   |   |   |   |   |   |   |
| Total assets at December 31         |   | $                                                        | 132,860 |   | $ | 167,764 |   | $ | 215,521 |   | $ | 231,209 |   | $ | 267,410 |   |
|                                |   |                                                     |    |   |   |   |   |   |   |   |   |
| Average dividends per Share         |   | $                                                        | 2.61    |   | $ | 3.74 |   | $ | 1.62 |   | $ | 2.73 |   | $ | 2.12 |   |

 
| ITEM 7. | MANAGEMENT’S DISCUSSION  AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|---------|---------------------------------------------------------------------------------------------|

 

Certain statements in this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and elsewhere in this report onForm 10-K constitute “forward-looking statements” within the meaning of theFederal Private Securities Litigation Reform Act of 1995.  These forward-looking statements involveknown and unknown risks, uncertainties and other factors which may cause theTrust’s actual results, performance or achievements to be materially differentfrom any future results, performance or achievements expressed or implied bythese forward-looking statements. These factors include, among other things,federal, state or local regulations; adverse changes in general economic orlocal conditions; the inability of the borrower to meet financial obligationson Additional Loans; prepayments of mortgages; failure of borrowers to payparticipation interests due to poor operating results at properties underlyingthe mortgages; uninsured losses and potential conflicts of interest between theTrust and its Affiliates, including the Advisor.

 

Liquidity and Capital Resources

 

At December 31, 2002, the Trust had liquidity consisting of cash andcash equivalents of approximately $20.5 million as well as the cash inflowsprovided by PIMs, PIMIs, MBS, cash and cash equivalents.  The Trust may also receive additional cashflow from the participation features of its PIMs and PIMIs.  The Trust anticipates that these sourceswill be adequate to provide the Trust with sufficient liquidity to meet itsobligations, including providing dividends to its investors.

 

The most significant demands on the Trust’s liquidity are quarterlydividends paid to investors of approximately $2.6 million and specialdividends.  Dividends are funded by interestincome received on PIMs, PIMIs, MBS and cash and cash equivalents net ofoperating expenses, and the principal collections received on PIMs, PIMIs andMBS.  The portion of dividends fundedfrom principal collections reduces the capital resources of the Trust.  As the capital resources of the 

 

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Trust decrease, the total cash flows to the Trust will also decreasewhich may result in periodic adjustments to the dividends paid to theinvestors.

 

The Advisor periodically reviews the dividend rate to determine whetheran adjustment is necessary based on projected future cash flows.  The current dividend rate is $.14 per Shareper quarter.  The Trustees, based on theAdvisor’s recommendations, generally set a dividend rate that provides forlevel quarterly distributions.  To theextent quarterly dividends do not fully utilize the cash available fordistribution and cash balances increase, the Trustees may adjust the dividendrate or distribute such funds through a special dividend.

 

In addition to providing guaranteed or insured monthly principal andinterest payments from the insured first mortgage or Fannie Mae MBS portion ofa PIM or PIMI, the Trust’s investments in the PIMs and PIMIs also may provideadditional income through the interest on the Additional Loan portion of thePIMIs as well as participation interest based on operating cash flow andincrease in the value realized upon the sale or refinance of the underlyingproperties.  However, these payments andcollection of the Additional Loan principal are neither guaranteed nor insuredand depend on the successful operations of the underlying properties.

 

The Trust received participation interest based on cash flows generatedby property operations from four of its investments during the twelve monthsended December 31, 2002.  The Trustreceived $90,334 in participation interest from Mequon Trails, $195,465 fromMartins Landing, $416,391 from the Lakes, and $14,401 from Rivergreens II.  In addition, the Trust received andrecognized participation interest related to the payoffs of the Sunset Summitand Norumbega Pointe PIMIs and the Mequon Trails PIM.

 

On March 7, 2003, the Trust received a prepayment of the Oasis atSpringtree Additional Loan note.  The Trustreceived $2,290,000 of Additional Loan principal and $2,365,276 of SharedAppreciation Interest.  The Trust willpay a special dividend of $.26 per share from the proceeds of the Oasis atSpringtree Additional Loan prepayment during the first half of 2003.

 

OnDecember 30, 2002, the Trust received a prepayment of the Mequon Trails PIMparticipation feature totaling $572,226. The payoff consisted of $385,000 ofShared Appreciation Interest and $187,226 of Minimum Additional Interest andShared Income Interest.  On January 27,2003, the Trust received $13,007,834 in proceeds from the Fannie Mae MBSrelated to Mequon.  The Trust will pay aspecial dividend of $.74 per share from the proceeds of the Mequon Trails PIMprepayment during the first half of 2003.

 

OnNovember 25, 2002, the Trust received $4,488,878, as a result of the payoff ofthe Sunset Summit Additional Loan. The payoff consisted of $1,900,000 for theprincipal due on the Additional Loan, base interest of $33,250, PreferredInterest of $1,532,498 and Participating Appreciation Interest of $1,023,130.On December 26, 2002, the Trust received $9,094,934 in proceeds from the FannieMae MBS related to Sunset.  During thefirst half of 2003 the Trust will pay a special dividend of $.74 per share fromthe prepayment of the Sunset Summit PIMI.

 

On March 28, 2002, the Trust received a prepayment of the WindmillLakes Subordinated Promissory Note and the Windmill Lakes Additional Loan.  The Trust received $2,000,000 of AdditionalLoan principal and $162,500 of Additional Loan interest.  As a result of the payoff, the Trustrecognized $562,500 of Additional Loan interest which had been received inprior years and was recorded as a reduction of the impaired Additional Loan inaccordance with the Financial Accounting Standards Board’s Statement 114,“Accounting by Creditors for Impairment of a Loan” (“FAS 114”) and theFinancial Accounting Standard Board’s Statement 118, “Accounting by Creditorsfor Impairment of a Loan- Income Recognition and Disclosures (“FAS118”).  As the entire Additional Loan principalbalance of $2,000,000 was paid in 2002, the remaining impairment provision of$500,000 was also reversed.  On April 25, 2002, the Trust received $10,727,382in principal proceeds on the first mortgage note from Windmill Lakes.  The Trust paid a special dividend of $.71per share from the proceeds of the Windmill Lakes prepayment on May 1, 2002.

 

On February 13, 2002, the Trust received a prepayment of the NorumbegaPointe Subordinated Promissory Note and the Norumbega Pointe AdditionalLoan.  The Trust received $3,063,000 ofAdditional Loan principal, $302,877 of Shared Appreciation Interest and$2,280,362 of Preferred Interest.  OnFebruary 25, 2002, the Trust received $15,123,167 in principal proceeds on thefirst mortgage note.  In addition, theTrust recognized $1,242,282 of Additional Loan interest that had beenpreviously received and recorded as deferred income on the Additional Loan. TheTrust paid a special dividend of $1.14 per Share from the proceeds of theNorumbega Pointe prepayment on March 12, 2002.

 

Due to the significant number of prepayments of mortgage investments in2002, the Trust saw a decrease in its overall mortgage investments ofapproximately 30% during 2002.  Inaddition, due to the cumulative prepayments since inception through December31, 2002, the Trust has approximately 34% of its original mortgage investmentsremaining.

 

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On July 23, 2001, theTrust received a prepayment of the Seasons Subordinated Promissory Note and theSeasons Additional Loan.  The Trustreceived $4,925,351 of the Additional Loan principal, $462,983 of surplus cash,$2,168,701 of preferred interest, $2,693,326 of contingent interest, $176,908of unpaid Base Interest on Additional Loan and $3,325,696 which represents theTrust’s portion of the residual split. On July 26, 2001, the Trust received $21,926,006 in principal proceedson the first mortgage note.  Inaddition, the Trust recognized $624,023 of Additional Loan interest that hadbeen previously received and recorded in deferred income on AdditionalLoans.  The Trust paid a specialdividend of $1.95 per Share on August 17, 2001 from the proceeds of the SeasonsPIMI prepayment.

 

The payoff of the Seasons PIMI was a result of the sale of theunderlying property by the borrower, Maryland Associates Limited Partnership(“MALP”), which is an affiliate of the Advisor, to an affiliate of MALP’sgeneral partner.  Because the sale ofthe underlying property was to an affiliate, the independent Trustees of theTrust were required to approve the transaction.  The independent Trustees approved the transaction based upon anumber of factors, including an appraisal of the underlying property preparedby an independent third party MAI appraiser. The purchase price paid by the affiliate for the underlying property was$1.6 million greater than the value indicated by such appraisal.  Both the Trustees and the Advisor believedthat the market capitalization rate utilized in the appraisal was too highbased on their knowledge of recent sales in the market and agreed that the truefair value was the ultimate purchase price paid by the affiliate.

 

On March 5, 2001, the Trust received a payoff of the Falls at HuntersPointe PIMI.  The Trust received theoutstanding balance on the insured mortgage of $12,347,267, the outstandingbalance on the Additional Loan of $650,000, Participating Income Interest onthe Additional Loan of $496,207 (including all of the delinquent amounts),  Preferred Interest on the Additional Loan of$492,543, Participating Appreciation Interest under the subordinate loanagreement of $1,070,304 and late fees on the delinquent Participating IncomeInterest of $11,021.  In addition, theTrust recognized $196,710 of Additional Loan interest and $311,132 ofParticipating Income Interest that had been previously received and recorded indeferred income on Additional Loans.  OnMarch 20, 2001, the Trust paid a special dividend of $.83 per share from theproceeds of the Falls at Hunters Pointe PIMI payoff.

 

In addition to the amounts received from the payoffs of the SunsetSummit, Windmill Lakes and Norumbega Pointe PIMIs, the Trust received allrequired contractual payments of Additional Loan interest due in 2002 from theremaining four PIMI investments.

 

Whether the operating performance of any of the remaining propertieswill provide sufficient cash flow from operations to pay either the AdditionalLoan interest or participation income will depend on factors that the Trust hasminimal control over.  Should theproperties be unable to generate sufficient cash flow to pay the AdditionalLoan interest, it would reduce the Trust’s distributable cash flow and couldaffect the value of the Additional Loan collateral.

 

The borrower on the Crossings Village PIMI has contacted the Trustregarding a payoff.  The Trust expectsthat this loan will not be paid off until October 2003 at the earliest due tothe yield maintenance provision on the first mortgage, which underlies the FannieMae MBS.

 

The borrower on the Rivergreens II PIM has contacted the Trustregarding the date that the prepayment penalty on the loan reduces from 9% to1%.  The penalty reduces in August 2003and it is the Advisors expectation that once it reduces the borrower will seeka refinancing which would pay off the loan.

 

There are contractual restrictions on the prepayment of the PIMs andPIMIs.  During the first five years ofthe investment, borrowers are generally prohibited from repayment.  During the second five years, the PIMborrowers can prepay the insured mortgage by paying the greater of a prepaymentpremium or the participation interest due at the time of the prepayment.  Similarly, the PIMI borrowers can prepay theinsured mortgage and the Additional Loan by satisfying the Preferred Returnobligation.  The participation featuresand the Additional Loans are neither insured nor guaranteed.  If the prepayment of the PIM or PIMI resultsfrom the foreclosure on the underlying property or an insurance claim, theTrust generally would not receive any participation interest or any amounts dueunder the Additional Loan.

 

The Trust has the option to call certain PIMs and all of the PIMIs byaccelerating their maturity. If the call feature is exercised for the whole PIMor PIMI then the insurance feature of the loan would be cancelled.  Therefore, the Advisor will determine themerits of exercising the call option for each PIM and PIMI as economicconditions warrant.  Such factors as thecondition of the asset, local market conditions, the interest rate environmentand available financing will have an impact on these decisions.

 

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Critical Accounting Policies

 

The Trust’s critical accounting policies relate to revenue recognitionrelated to the Trust’s PIM and PIMI investments, impaired mortgage loans,amortization of Prepaid Fees and Expenses and the carrying value of itsMBS.  The Trust’s policies are asfollows:

 

The Trust accounts for its MBS portion of a PIM or PIMI investment inaccordance with the Financial Accouting Standards Board’s Statement 115,“Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”),under the classification of held to maturity as these investments have aparticipation feature.  As a result, theTrust would not sell or otherwise dispose of the MBS.  Accordingly, the Trust has both the intention and ability to holdthese investments to expected maturity. The Trust carries these MBS atamortized cost.  The insured mortgageportion of the Federal Housing Administration (“FHA”) PIM or PIMI is carried atamortized cost.  The Trust holds thesemortgages at amortized cost since they are fully insured by the FHA.  The Additional Loans are carried atamortized cost unless the Advisor believes there is an impairment in value, inwhich case a valuation allowance is established in accordance with FAS 114“Accounting by Creditors for Impairment of a Loan” and FAS 118 “Accounting byCreditors for Impairment of a Loan-Income Recognition and Disclosures”.  The Trust, in accordance with the FAS 115,classifies its MBS portfolio as available-for-sale. The Trust classifies itsMBS portfolio as available-for-sale as a portion of the MBS portfolio mayremain after all of the PIMs and PIMIs payoff and it will then be necessary tosell the remaining MBS portfolio in order to close out the Trust.  In addition, other situations such asliquidity needs could arise which would necessitate the sale of a portion ofthe MBS portfolio.  The Trust carriesits MBS at fair market value and reflects any unrealized gains (losses) as aseparate component of Shareholders’ Equity. The Trust amortizes purchase premiums or discounts over the life of theunderlying mortgages using the effective interest method.

 

Basic interest is recognized based on the stated rate of the Departmentof Housing and Urban Development (“HUD”) Insured Mortgage loan  (less the servicer’s fee) or the coupon rateof the Fannie Mae MBS.  The Trustrecognizes interest related to the participation features when the amountbecomes fixed and the transaction that gives rise to such amount is finalized,cash is received and all contingencies are resolved.  This could be the sale or refinancing of the underlying realestate, which results in a cash payment to the Trust or a cash payment made tothe Trust from surplus cash relative to the participation feature.  The Trust defers the recognition ofAdditional Loan interest payments as income to the extent these interestpayments are from escrows established with the proceeds of the AdditionalLoan.  When the properties underlyingthe PIMIs generate sufficient cash flow to make the required Additional Loaninterest payments and the Additional Loan value is deemed collectible, theTrust recognizes income as earned and commences amortizing deferred interestamounts into income over the remaining estimated term of the AdditionalLoan.  During periods where mortgageloans are impaired the Trust suspends amortizing deferred interest.

 

When the properties underlying the PIMIs generate sufficient cash flowto make the required Additional Loan interest payments and the Additional Loanvalue is deemed collectible, the Trust recognizes income as earned andcommences amortizing deferred interest amounts into income over the remainingestimated term of the Additional Loan. During periods where mortgage loans areimpaired the Trust suspends amortizing deferred interest.

 

The Trust also fully reserves the portion of any Additional Loaninterest payment satisfied through the issuance of an operating loan and anyassociated interest due on such operating loan.  The Trust will recognize the income related to the operating loanwhen the borrower repays amounts due under the operating loan.

 

Impaired loans are thoseAdditional Loans for which the Advisor believes the collection of all amountsdue in accordance with the contractual terms of the loan agreement is notlikely.  Impaired loans are measuredbased on the fair value of the underlying collateral net of estimated sellingcosts.  The Trust measures impairment onthese loans quarterly.  Interestreceived on impaired loans is generally applied against the loan principal.

 

Prepaid fees and expensesrepresent prepaid acquisition fees and expenses and prepaid participation servicingfees paid for the acquisition and servicing of PIMs and PIMIs.  The Trust amortizes prepaid acquisition feesand expenses using a method that approximates the effective interest methodover a period of ten to twelve years, which represents the estimated life ofthe underlying mortgage. The prepaid participation servicing fees are amortizedusing a method that approximates the effective interest method over a ten-yearperiod beginning at final endorsement of the loan if a HUD-insured loan and atclosing if a Fannie Mae loan.  Upon therepayment of a PIM or PIMI, any unamortized acquisition fees and expenses andunamortized participation servicing fees related to such loan are expensed.

 

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| ITEM 7A. | QUANTITATIVE AND  QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
|----------|-------------------------------------------------------------|

 

Assessment of Credit Risk

 

The Trust’s investments in insured mortgages and MBS are guaranteedand/or insured by Fannie Mae, FHLMC, GNMA and HUD, and therefore, the certaintyof their cash flows and the risk of material loss of the amounts investeddepends on the creditworthiness of these entities.

 

Fannie Mae is a federally chartered private corporation that guaranteesobligations originated under its programs. FHLMC is a federally chartered corporation that guarantees obligationsoriginated under its programs.  Theseobligations are not guaranteed by the U.S. Government or the Federal Home LoanBank Board.  However, Fannie Mae andFHLMC are two of the largest corporations in the United States with significantexperience in mortgage securitizations. In addition, their MBS carry the highest credit rating given tofinancial instruments.  GNMA guaranteesthe full and timely payment of principal and basic interest on the securitiesit issues, which represent interests in pooled mortgages insured by HUD.  Obligations insured by HUD, an agency of theU.S. Government, are backed by the full faith and credit of the U.S.Government.

 

Collection of the principal and interest of the Additional Loans andinterest on the participation features have risks similar to those associatedwith higher risk debt instruments, including: reliance on the owner’s operating skills, ability to maintain occupancylevels, control operating expenses, ability to maintain the properties andobtain adequate insurance coverage. Operations also may be affected by adverse changes in general economicconditions, local conditions, and changes in governmental regula­tions, realestate zoning laws, or tax laws; and other circumstances over which the Trustmay have little or no control.

 

The Trust’s investments also include cash and cash equivalents ofapproximately $20 million of Agency paper, which is issued by GovernmentSponsored Enterprises with a credit rating equal to the top rating category ofa nationally recognized statistical rating organization.

 

Interest Rate Risk

 

The Trust’s primary market risk exposure is to interest rate risk,which can be defined as the exposure of the Trust’s net income, comprehensiveincome or financial condition to adverse movements in interest rates.  At December 31, 2002, the Trust’s PIMs,PIMIs and MBS comprise the majority of the Trust’s assets.  Decreases in interest rates may acceleratethe prepayment of the Trust’s investments. The Trust does not utilize any derivatives or other instruments tomanage this risk as the Trust plans to hold all of its PIM and PIMI investmentsto expected maturity while it is expected that substantially all of the MBSwill prepay over the same time period thereby mitigating any potential interestrate risk to the disposition value of any remaining MBS.

 

The Trust monitors prepayments and considers prepayment trends, as wellas dividend requirements of the Trust, when setting regular dividendpolicy.  For MBS, the fund forecastsprepayments based on trends in similar securities as reported by statisticalreporting entities such as Bloomberg. For PIMs and PIMIs, the Trust incorporates prepayment assumptions intoplanning as individual properties notify the Trust of the intent to prepay oras they are scheduled to mature.

 

The following table provides information about the Trust’s financialinstruments that are sensitive to changes in interest rates.  For mortgage investments, the table presentsprincipal cash flows and related weighted average interest rates (“WAIR”) byexpected maturity dates.  The expectedmaturity date is the contractual maturity as adjusted for expectations ofprepayments.

 

8

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|                            |   | **Expected  maturity dates ($ in thousands)** |   |
|---------------------------------|--------|-----------------------------------------------|--------|
|                            |   | **2003**                                      |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total  Face  Value** |   | **Fair Value(1)** |   |
|                            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-sensitive  assets:     |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| MBS                             |   | $                                             | 1,553  |   | $ | 1,259 |   | $ | 1,025 |   | $ | 840 |   | $ | 693 |   | $ | 5,496 |   | $ | 10,866 |   | $ | 11,521 |   |
| WAIR                            |   | 7.58                                          | %      | 7.58 | % | 7.58 | % | 7.58 | % | 7.58 | % | 7.58 | % | 7.58 | % |   |   |
|                            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| PIMS                            |   | 19,003                                        |   | 130 |   | 140 |   | 151 |   | 163 |   | 17,281 |   | 36,868 |   | 38,345 |   |
| WAIR                            |   | 7.34                                          | %      | 7.34 | % | 7.34 | % | 7.34 | % | 7.34 | % | 7.34 | % | 7.05 | % |   |   |
|                            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| PIMIS                           |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Insured  Mortgages              |   | 12,191                                        |   | 730 |   | 790 |   | 855 |   | 926 |   | 34,149 |   | 49,641 |   | 51,808 |   |
| WAIR                            |   | 6.72                                          | %      | 6.72 | % | 6.72 | % | 6.72 | % | 6.72 | % | 6.72 | % | 6.73 | % |   |   |
|                            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Additional Loans                |   | 4,874                                         |   | — |   | — |   | — |   | — |   | 6,880 |   | 11,754 |   | 11,754 |   |
| WAIR                            |   | 7.00                                          | %      | 7.00 | % | 7.00 | % | 7.00 | % | 7.00 | % | 7.00 | % | 7.00 | % |   |   |
|                            |   |                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Interest-Sensitive Assets |   | $                                             | 37,621 |   | $ | 2,119 |   | $ | 1,955 |   | $ | 1,846 |   | $ | 1,782 |   | $ | 63,806 |   | $ | 109,129 |   | $ | 113,428 |   |

 

----

(1)The methodology used by the Trust to estimate the fair value of each class offinancial instrument is described in Note I to the Trust’s financial statementspresented in Appendix A to this report. As described in that note, the Trust does not include an estimate ofvalue for the participation interest associated with its PIM and PIMIinvestments.

 

Also included in the Trust’s assets are cash and cash equivalents.  Due to the short term maturity of theseinvestments, generally less than three months, the Trust is not exposed tosignificant interest rate risk on these investments.

 

Operations

 

The following relates tothe operations of the Trust during the years ended December 31, 2002, 2001, and2000.

 
|                                                  |   | **(amounts  in thousands, except per Share amounts)** |   |
|-------------------------------------------------------|--------|-------------------------------------------------------|--------|
|                                                  |   | **Years  Ended December 31,**                         |   |
|                                                  |   | **2002  Amount**                                      |   | **2001  Amount** |   | **2000  Amount** |   |
| Interest on PIMs  and PIMIs:                          |   |                                                  |   |   |   |   |   |
| Basic interest                                        |   | $                                                     | 6,873  |   | $ | 9,674 |   | $ | 11,260 |   |
| Additional Loan  interest                             |   | 2,912                                                 |   | 2,208 |   | 1,784 |   |
| Participation  interest                               |   | 6,428                                                 |   | 11,873 |   | 1,915 |   |
| Interest income  on MBS                               |   | 860                                                   |   | 1,197 |   | 1,455 |   |
| Interest income  – cash and cash equivalents     |   | 286                                                   |   | 378 |   | 564 |   |
| Trust expenses                                        |   | (1,588                                                | )      | (2,081 | ) | (2,215 | ) |
| Amortization of  prepaid fees and expenses            |   | (2,234                                                | )      | (2,608 | ) | (2,132 | ) |
| Reduction of  provision for impaired Additional Loans |   | 500                                                   |   | 1,500 |   | 994 |   |
| Net Income                                            |   | $                                                     | 14,037 |   | $ | 22,141 |   | $ | 13,625 |   |
|                                                  |   |                                                  |   |   |   |   |   |
| Weighted Average  Shares Outstanding                  |   | 18,371,477                                            |   | 18,371,477 |   | 18,371,477 |   |

 

The Trust’s net income decreased in 2002 when compared to 2001primarily due to decreases in basic interest on PIMs and PIMIs, participationinterest and a reduction in the decrease of the provision for impaired mortgageloans.  These items were partiallyoffset by an increase in Additional Loan interest.  Basic interest on PIMs and PIMIs decreased due to the NorumbegaPointe and Windmill Lakes payoffs in 2002 and the payoff of the Falls atHunters Pointe and the Seasons 

 

9

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PIMIs in 2001.  Participationinterest decreased primarily due to the participation interest collected fromthe Seasons and Hunters Pointe payoffs in 2001 being greater than theparticipation interest collected from the Norumbega, Falls at Hunters Pointe,Sunset Summit and Mequon Trails payoffs in 2002.  The provision for impaired mortgage on the Windmill Lakes PIMIdecreased by $1,500,000 in 2001 whereas it only decreased by $500,000 in2002.  Additional Loan interestincreased primarily due to the recognition of deferred income from the NorumbegaPointe payoff and base interest recognized from the Windmill Lakes payoff.

 

The Trust’s net income increased in 2001 when compared to 2000primarily due to an increase in participation interest on PIMs and PIMIs.  This was partially offset by a decrease inbasic interest from PIMs and PIMIs. Participation interest increased primarily due to the Seasons payoff inJuly 2001 and the Falls at Hunters Pointe payoff in March 2001.  The payoffs also caused basic interest fromPIMs and PIMIs to decrease.

 
| ITEM 8. | FINANCIAL STATEMENTS  AND SUPPLEMENTARY DATA |
|---------|----------------------------------------------|

 
|   | See Appendix A to this  report. |
|--------|---------------------------------|

 
| ITEM 9. | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
|---------|---------------------------------------------------------------------------------------|

 
|   | None. |
|--------|-------|

 

PART III

 
| ITEM 10. | DIRECTORS AND EXECUTIVE  OFFICERS OF THE REGISTRANT |
|----------|-----------------------------------------------------|

 

Information as to theTrustees and Executive Officers of Krupp Government Income Trust II is asfollows:

 
|   |                     |   | **Position with Krupp**                   |   | **Date of**    |   | **Term**    |   |
|--------|--------------------------|--------|-------------------------------------------|--------|----------------|--------|-------------|--------|
|   | **Name and  Age**        |   | **Government Income Trust II**            |   | **Election**   |   | **Expires** |   |
|   |                     |   |                                      |   |           |   |        |   |
|   | Douglas Krupp (56)       |   | Chairman of Board of Trustees and Trustee |   | May, 1996      |   | May, 2003   |   |
| *      | Charles N. Goldberg (61) |   | Trustee                                   |   | April, 1991    |   | May, 2003   |   |
| *      | J. Paul Finnegan (78)    |   | Trustee                                   |   | April, 1991    |   | May, 2003   |   |
| *      | Stephen Puleo (68)       |   | Trustee                                   |   | February, 2001 |   | May, 2003   |   |
|   | Alan Reese (49)          |   | Treasurer                                 |   | February, 2003 |   | N/A         |   |
|   | Scott D. Spelfogel (42)  |   | Clerk                                     |   | November, 1991 |   | N/A         |   |
|   | MaryBeth Bloom (29)      |   | Assistant Clerk                           |   | November, 2000 |   | N/A         |   |

 

----

* Independent Trustee

 

Douglas Krupp co-founded and serves as Co-Chairman and Chief ExecutiveOfficer of The Berkshire Group, an integrated real estate financial servicesfirm engaged in real estate acquisitions, property management, investmentsponsorship, venture capital investing, mortgage banking, financial management,and ownership of two operating companies through private equity investments.  Mr. Krupp has held the position ofCo-Chairman since The Berkshire Group was established as The Krupp Companies in1969 and he has served as the Chief Executive Officer since 1992. He is agraduate of Bryant College where he also received an honorary Doctor of Sciencein Business Administration in 1989.

 

Charles N. Goldberg iscurrently a partner of Oppel, Goldberg & Saenz, PLLC.  Prior to that he was of counsel to the lawfirm of Broocks, Baker & Lange, L.L.P., a position he held from December1997 to May 2000.  Prior to joiningBroocks, Baker & Lange, L.L.P., Mr. Goldberg was a partner in the law firmof Hirsch& Westheimer from March 1996 to December 1997.  Prior to Hirsch & Westheimer, he was theManaging Partner of Goldberg Brown, Attorneys at Law from 1980 to March 1996.He received a B.B.A. degree and a J.D. degree from the University ofTexas.  He is a member of the State Barof Texas and is admitted to practice before the U.S. Court of Appeals, FifthCircuit and U.S. District Court, Southern District of Texas.  He currently serves as a Trustee of KruppGovernment Income Trust and Krupp Government Income Trust II.

 

J. Paul Finnegan retired as a partner of Coopers & Lybrand in1987.  Since then, he has been engagedin business as a consultant, director and arbitrator.  Mr. Finnegan holds a B.A. degree from Harvard College, a J.D.degree from Boston College Law School and an ASA from Bentley College. Mr.Finnegan currently serves as a Trustee of Krupp Government Income Trust andKrupp Government Income Trust II and as a director of Scituate Federal SavingsBank.

 

10

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Stephen Puleo is currently engaged in business as a consultant anddirector.  He retired as a director ofCoopers & Lybrand, where he worked from 1995 to 1997 primarily servicingreal estate industry clients.  From 1993to 1994, Mr. Puleo was a tax director for Deloitte & Touche.  From 1984 to 1993, Mr. Puleo held thepositions of Executive Vice President and Chief Financial Officer of a predecessorto The Berkshire Group.  Prior to that,Mr. Puleo was the Chairman of the National Real Estate Industry Group ofCoopers & Lybrand where he provided various real estate services and was asenior tax partner in charge of the Northeast Region.  He is a graduate of McNeese State University and attended theExecutive Development Program at the Tuck School of Business at DartmouthCollege.  He is a Certified PublicAccountant and currently serves as director of Simpson Housing LimitedPartnership of Denver, Colorado.  Hecurrently serves as a Trustee of Krupp Government Income Trust and KruppGovernment Income Trust II.

 

Alan Reese is the Executive Vice President, Corporate Operations andChief Financial Officer of Berkshire Mortgage Finance.  Mr. Reese joined Berkshire Mortgage Financein February of 2003 and is currently responsible for the accounting, financialplanning and reporting, treasury, information technology, mortgage trading deskand loan servicing functions.  Prior tojoining Berkshire Mortgage Finance, Mr. Reese was the Chief Financial Officerof Visible Markets, Inc. from 2000 to 2001 and was engaged in business as aconsultant from 2001-January, 2003. Prior to Visible Markets, Inc., he was the Senior Vice President andChief Financial Officer of Mortgage Lenders Network USA, Inc. from1998-2000.  Mr. Reese held severalpositions with BankBoston Corporation from 1990 to 1998 and most recently heldthe position of Director of Operations, National Consumer Lending from1996-1998.  In addition, Mr. Reese wasemployed with Coopers & Lybrand from 1976 to 1990, and was a partner from1987-1990.  Mr. Reese presently serveson the Board of Trustees for Berklee College of Music.  He received a B.B.A. degree from theUniversity of Wisconsin – Eau Claire and is a Certified Public Accountant.

 

Scott D. Spelfogel is the Clerk of the Trust and is Senior VicePresident and General Counsel to The Berkshire Group. Prior to 1997, he servedas Vice President and Assistant General Counsel.  Before joining the firm in November 1988, he was a litigator inprivate practice in Boston.  He receiveda Bachelor of Science degree in Business Administration from Boston University,a Juris Doctor Degree from Syracuse University’s College of Law, and a Masterof Laws degree in Taxation from Boston University Law School.  He is admitted to practice law inMassachusetts and New York, is a member of the American, Boston, Massachusettsand New York State bar associations and is a licensed real estate broker inMassachusetts.

 

MaryBeth Bloom is the Assistant Clerk of the Trust and is AssistantGeneral Counsel to The Berkshire Group. Prior to joining the company in August 2000, she was an attorney withJohn Hancock Financial Services.  Shereceived a B.A. degree from the College of the Holy Cross in 1995 and a J.D.degree from New England School of Law in 1998. She is admitted to practice law in Massachusetts and New York and is amember of the American Bar Association.

 

In addition, the following are deemed to be Executive Officers of theregistrant:

 

George Krupp (age 58) is the Co-Founder and Co-Chairman of TheBerkshire Group, an integrated real estate financial services firm engaged inreal estate acquisitions, property management, investment sponsorship, venturecapital investing, mortgage banking, financial management, and ownership of twooperating companies through private equity investments. Mr. Krupp has held theposition of Co-Chairman since The Berkshire Group was established as The KruppCompanies in 1969.  Mr. Krupp attendedthe University of Pennsylvania and Harvard University and holds a Master’sDegree in History from Brown University. Douglas and George Krupp are brothers.

 

Peter F. Donovan (age 49) is Chief Executive Officer of BerkshireMortgage Finance which position he has held since January of 1998.  In this capacity, he oversees the strategicgrowth plans of this mortgage banking firm. Berkshire Mortgage Finance is the 12th largest in the United Statesbased on servicing and asset management of a $16.4 billion loan portfolio.  He served as President of Berkshire MortgageFinance from January 1993 to January 1998 and in that capacity he directed theproduction, underwriting, servicing and asset management activities of the firm.Prior to that, he was Senior Vice President of Berkshire Mortgage Finance andwas responsible for all participating mortgage originations.  Before joining the firm in 1984, he wasSecond Vice President, Real Estate Finance for Continental Illinois NationalBank & Trust, where he managed a $300 million construction loan portfolioof commercial properties.  Mr. Donovanreceived a B.A. from Trinity College and an M.B.A. degree from NorthwesternUniversity.  Mr. Donovan is currently amember of the Advisory Council for Fannie Mae.

 

Ronald Halpern (age 61) is President and Chief Operating Officer ofBerkshire Mortgage Finance.  He hasserved in these positions since January 1998 and in this capacity, he isresponsible for the overall operations of the Company. Prior to January 1998,he was Executive Vice President, managing the underwriting, closing, portfoliomanagement and servicing departments for Berkshire Mortgage Finance. Beforejoining the firm in 1987, he held senior management positions with theDepartment of Housing and Urban Development in Washington D.C. and several HUDregional offices. Mr. Halpern has over 30 years of experience in real estatefinance, which includes his experience as prior 

 

11

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Chairman of the Mortgage Bankers Association Multifamily HousingCommittee. He holds a B.A. degree from the University of the City of New Yorkand J.D. degree from Brooklyn Law School.

 

Carol J.C. Mills (age 53)is Senior Vice President for Loan Management of Berkshire Mortgage Finance andin this capacity, she is responsible for the Asset Management functions ofBerkshire Mortgage Finance. She manages the estimated $16.4 billion portfolioof loans.  Ms. Mills joined Berkshire inDecember 1997 as Vice President and was promoted to Senior Vice President inJanuary 1999.  From January 1989 throughNovember 1997, Ms. Mills was Vice President of First Winthrop Corporation andWinthrop Financial Associates, in Cambridge, Massachusetts.  Ms. Mills earned a B.A. degree from MountHolyoke College and a Master of Architecture degree from HarvardUniversity.  Ms. Mills is a member ofthe Real Estate Finance Association, New England Women in Real Estate, theMortgage Bankers Association and the Servicing Advisory Council for FreddieMac.

 
| ITEM 11. | EXECUTIVE COMPENSATION |
|----------|------------------------|

 

Except for the Independent Trustees (as described below), the Trusteesand Officers of the Trust have not been and will not be compensated by theTrust for their services.  However, theOfficers will be compensated by the Advisor or an affiliate of the Advisor.

 

Compensation of Trustees

 

The Trust paid each of the Independent Trustees (Charles N. Goldberg,J. Paul Finnegan and Stephen Puleo) a fee of $25,000 in 2002.

 
| ITEM 12. | SECURITY OWNERSHIP OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED MANAGEMENT MATTERS |
|----------|------------------------------------------------------------------------------------------------|

 

As of December 31, 2002, no person owned of record or was known by theAdvisor to own beneficially more than 5% of the Trust’s 18,371,477 outstandingShares.  The only Shares held by theAdvisor or any of its affiliates consist of the original 10,000 Shares held bythe Advisor.

 
| **Class of  Stock**           |   | **Name of Beneficial   Owner**                     |   | **Amount and Nature of   Beneficial Interest** |   | **Percent   of Class** |
|-------------------------------|--------|----------------------------------------------------|--------|------------------------------------------------|--------|------------------------|
|                          |   |                                               |   |                                           |   |                   |
| Shares of Beneficial Interest |   | Douglas Krupp  One Beacon Street  Boston, MA 02108 |   | 10,000 Shares**                                |   | ***                    |
|                          |   |                                               |   |                                           |   |                   |
| Shares of Beneficial Interest |   | All Directors and Officers                         |   | 10,000 Shares                                  |   | ***                    |

 

----

** Mr. Krupp is abeneficial owner of the 10,000 Shares held by Berkshire Mortgage AdvisorsLimited Partnership, the Advisor to the Company, by virtue of being a directorof Berkshire Funding Corporation, the general partner of Berkshire MortgageAdvisors Limited Partnership.  In eachcase where Mr. Krupp is a beneficial owner of Shares he has shared voting andinvestment powers.

 

*** The amountowned does not exceed one percent of the Shares of beneficial interest of theTrust outstanding as of December 31, 2002.

 
| ITEM 13. | CERTAIN RELATIONSHIPS  AND RELATED TRANSACTIONS |
|----------|-------------------------------------------------|

 

Under the terms of theAdvisory Service Agreement, the Advisor receives an Asset Management Fee equalto .75% per annum of the value of the Trust’s actual and committed investedassets payable quarterly.  During 2002,the Advisor received $943,476 in Asset Management Fees.

 

The Trust also reimbursesaffiliates of the Advisor for certain expenses incurred in connection withmaintaining the books and records of the Trust, the preparation and mailing offinancial reports, tax information and other communications to investors, andlegal fees and expenses.  During 2002,The Berkshire Companies Limited Partnership and Berkshire Mortgage FinanceLimited Partnership, affiliates of the Advisor, received a total of $235,277 inreimbursements from the Trust.

 

12

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| ITEM 14. | CONTROLS AND PROCEDURES |
|----------|-------------------------|

 

(a) Evaluation of Disclosure Controls and Procedures

 

Within the 90 days prior to the date of this Annual Report on Form10-K, the Chairman of the Board and the Chief Accounting Officer carried out anevaluation of the effectiveness of the design and operation of the Trust’sdisclosure controls and procedures. Based upon that evaluation, the Chairman of the Board and the ChiefAccounting Officer concluded that the Trust’s disclosure controls andprocedures were effective as of the date of their evaluation in timely alertingthem to material information relating to the Trust required to be included inthis Annual Report on Form 10-K.

 

(b) Changes in Internal Controls

 

There were no significant changes in the Trust’s internal controls orin other factors that could significantly affect such internal controlssubsequent to the date of the evaluation described in paragraph (a) above.

 

PART IV

 
| ITEM 15. | EXHIBITS, FINANCIAL  STATEMENT SCHEDULES AND REPORTS ON FORM 8-K |
|----------|------------------------------------------------------------------|

 
| (a)    | 1.                  | Financial Statements -  see Index to Financial Statements and Supplementary Data included under Item  8, Appendix A, on page F-2 of this report.                                                                                                                                                                      |
|--------|---------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                |                                                                                                                                                                                                                                                                                                                  |   |   |
|   | 2.                  | Financial Statement  Schedules - see Index to Financial Statements and Supplementary Data included  under Item 8, Appendix A, on page F-2 of this report.  All schedules are omitted as they are not  applicable, not required or the information is provided in the Financial  Statements or the Notes thereto. |
|   |                |                                                                                                                                                                                                                                                                                                                  |
| (b)    | Reports on Form 8-K |

 
| **Date of  Report** |   | **Event Reported**                |   | **Financial  StatementsIncluded** |
|---------------------|--------|-----------------------------------|--------|-----------------------------------|
| November 25, 2002   |   | Updates on Potential Loan Payoffs |   | None                              |

 
| (c) | Exhibits: |
|-----|-----------|

 

Number andDescription

Under RegulationS-K  

 

The followingreflects all applicable Exhibits required under Item 601 of Regulation S-K:

 

(4)                              Instrumentsdefining the rights of security holders including indentures:

 

(4.1)                        FourthAmended and Restated Declaration of Trust filed with The MassachusettsSecretary of State on September 25, 1991 [Included as Exhibit 4.8 toPost-effective Amendment No. 1 to Registrant’s Registration Statement on FormS-11 dated September 26, 1991 (File No. 33-39033)].*

 

(4.2)                        SubscriptionAgreement Specimen [Included as Exhibit C to Prospectus included inPost-effective Amendment No. 1 to Registrant’s Registration Statement on FormS-11 dated September 26, 1991 (File No. 33-39033)].*

 

(10)                            MaterialContracts

 

(10.1)                  AdvisoryServices Agreement dated September 11, 1991 between Krupp Government IncomeTrust II and Berkshire Realty Advisors Limited Partnership (formerly known asKrupp Realty Advisors Limited Partnership)[Exhibit 10.1 to Registrant’s reporton Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].*

 

(10.2)                  Assignment andAssumption Agreement between Berkshire Realty Advisors Limited Partnership andBerkshire Mortgage Advisors Limited Partnership [Exhibit 10.2 to Registrant’sreport on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].*

 

13

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(10.3)                  Waiver andStandstill Agreement, dated as of August 22, 2002, by and among Krupp GovernmentIncome Trust, Krupp Government Income Trust II, Berkshire Income Realty, Inc.and Berkshire Income Realty – OP, L.P +

 

(10.4)                  Form of Amendedand Restated Voting Agreement among Krupp Government Income Trust, KruppGovernment Income Trust II and Berkshire Income Realty, Inc. +

 

(10.5)                  Extension andWaiver and Standstill Agreement, dated March 5, 2003, by and among KruppGovernment Income Trust, Krupp Government Income Trust II, Berkshire IncomeRealty, Inc. and Berkshire Income Realty, OP, L.P. +

 

Mequon Trails

 

(10.6)                  Supplement toProspectus dated January 1, 1993 for Federal National Mortgage Association poolnumber MX-073025 [Exhibit  19.1. toRegistrant’s Report on Form 10-Q for the quarter ended March 31, 1993 (File No.0-20164)].*

 

(10.7)                  Subordinatedpromissory note dated December 21, 1992 by and between Mequon Trails TownhomesLimited Partnership and Krupp Government Income Trust II [Exhibit 19.2 toRegistrant’s Report on Form 10-Q for the quarter ended March 31, 1993 (File No.0-20164)].*

 

(10.8)                  SubordinateMultifamily Mortgage dated December 21, 1992 between Mequon Trails TownhomesLimited Partnership and Krupp Government Income Trust II.  [Exhibit 10.5 to Registrant’s report on Form10-K for the year ended December 31, 1995 (File No. 0-20164)].*

 

(10.9)                  SubordinationAgreement dated December 21, 1992 between Krupp Mortgage Company L.P., KruppGovernment Income Trust II and Mequon Trails Townhomes LimitedPartnership.  [Exhibit 10.6 toRegistrant’s report on Form 10-K for the year ended December 31, 1995 (File No.0-20164)].*

 

Martin’s Landing

 

(10.10)            Subordinated LoanAgreement, dated November 9, 1993, between TRC Realty Incorporated - ML, MLAssociates Limited Partnership (“Borrower”) and Krupp Government Income TrustII (“Holder”) [Exhibit 10.9 to Registrant’s annual report on Form 10-K forfiscal year ended December 31, 1993 (File No. 0-20164)].*

 

(10.11)            SubordinationAgreement dated November 9, 1993 between ML Associates, L.P., and KruppGovernment Income Trust II.  [Exhibit10.22 to Registrant’s report on Form 10-K for the year ended December 31, 1995(File No. 0-20164)].*

 

(10.12)            Assignment ofSubordination Agreement dated November 9, 1993 from Berkshire Mortgage FinanceLimited Partnership to the Federal National Mortgage Association by and betweenML Associates, L.P., Berkshire Mortgage Finance Limited Partnership and KruppGovernment Income Trust II.  [Exhibit10.23 to Registrant’s report on Form 10-K for the year ended December 31, 1995(File No. 0-20164)].*

 

(10.13)            Supplement toProspectus dated December 1, 1993 for Federal National Mortgage Associationpool number MX - 073029.  [Exhibit 10.24to Registrant’s report on Form 10-K for the year ended December 31, 1995 (FileNo. 0-20164)].*

 

Crossings Village

 

(10.14)            Subordinated LoanAgreement, dated September 28, 1993 between Crossings Village WestlakeAssociates (“Borrower”) and Krupp Government Income Trust II (“Holder”)[Exhibit10.10 to Registrant’s annual report on Form 10-K for fiscal year ended December31, 1993 (File No. 0-20164)].*

 

(10.15)            Subordinated Notedated September 28, 1993 between Crossings Village Westlake Associates andKrupp Government Income Trust II [Exhibit 10.16 to Registrant’s report on Form10-K for the year ended December 31, 1994 (File No. 0-20164)].*

 

14

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(10.16)            SubordinationAgreement dated September 28, 1993 between Washington Capital DUS Inc.,Crossings Village Westlake Associates and Krupp Government Income TrustII.  [Exhibit 10.27 to Registrant’s reporton Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].*

 

Oasis atSpringtree

 

(10.17)            Subordinate Note datedJune 16, 1994 between Oasis at Springtree, Inc. and Krupp Government IncomeTrust II [Exhibit 10.33 to Registrant’s report on Form 10-K for the year endedDecember 31, 1994 (File No. 0-20164)].*

 

(10.18)            Subordinated LoanAgreement dated August 11, 1994 between Joseph Kodsi and Albert Kodsi, Oasis atSpringtree, Inc., and Krupp Government Income Trust II.  [Exhibit 10.48 to Registrant’s report onForm 10-K for the year ended December 31, 1995 (File No. 0-20164)].*

 

(10.19)            SubordinationAgreement dated August 11, 1994 between Berkshire Mortgage Finance LimitedPartnership, Oasis at Springtree, Inc. and Krupp Government Income TrustII.  [Exhibit 10.49 to Registrant’sreport on Form 10-K for the year ended December 31, 1995 (File. No 0-20164)].*

 

(10.20)            Assignment ofSubordination Agreement dated August 11, 1994 for Berkshire Mortgage FinanceLimited Partnership with Federal National Mortgage Association by and betweenOasis at Springtree, Inc., Berkshire Mortgage Finance Limited Partnership andKrupp Government Income Trust II. [Exhibit 10.50 to Registrant’s report on Form 10-K for the year endedDecember 31, 1995 (File No. 0-20164)].*

 

(10.21)            SubordinatedMultifamily Mortgage Assignment of Rents and Security Agreement dated August11, 1994 between Oasis at Springtree, Inc. and Krupp Government Income TrustII.  [Exhibit 10.51 to Registrant’sreport on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].*

 

(10.22)            Supplement toProspectus dated January 1, 1994 for Federal National Mortgage Association poolnumber MX - 073043.  [Exhibit 10.52 toRegistrant’s report on Form 10-K for the year ended December 31, 1995 (File No.0-20164)].*

 

The Willows

 

(10.23)            Supplement toProspectus dated January 1, 1994 for Federal National Mortgage Association poolnumber MX - 073057 [Exhibit 10.42 to Registrant’s report on Form 10-K for theyear ended December 31, 1994 (File No. 0-20164)].*

 

The Lakes

 

(10.24)            Subordinated LoanAgreement dated June 29, 1995, between Lake Associates, L. P. and KruppGovernment Income Trust II [Exhibit 10.5 to Registrant’s report on Form 10-Qfor the quarter ended September 30, 1995 (File No. 0-20164)].*

 

(10.25)            Subordinate Note datedJune 29, 1995, between Lake Associates, L. P. and Krupp Government Income TrustII [Exhibit 10.6 to Registrant’s report on Form 10-Q for the quarter endedSeptember 30, 1995 (File No. 0-20164)].*

 

(10.26)            Subordinate MultifamilyMortgage to Secure Debt Agreement dated June 29, 1995, between Lake Associates,L. P.  and Krupp Government Income TrustII [Exhibit 10.7 to Registrant’s report on Form 10-Q for the quarter endedSeptember 30, 1995 (File No. 0-20164)].*

 

(10.27)            SubordinationAgreement dated June 29, 1995, between Berkshire Mortgage Finance LimitedPartnership, Lake Associates, L. P. and Krupp Government Income Trust II[Exhibit 10.8 to Registrant’s report on Form 10-Q for the quarter endedSeptember 30, 1995 (File No. 0-20164)].*

 

(10.28)            Assignment ofSubordination Agreement dated June 29, 1995, from Berkshire Mortgage FinanceLimited Partnership to the Federal National Mortgage Association by andbetween, Lake Associates, L.P. and Berkshire Mortgage Finance LimitedPartnership and Krupp Government Income Trust II [Exhibit 10.9 to Registrant’sreport on Form 10-Q for the quarter ended September 30, 1995 (File No.0-20164)].*

 

15

----

 

(10.29)            Supplement toProspectus dated November 1, 1994 for Federal National Mortgage Associationpool number MX - 073149 [Exhibit 10.10 to Registrant’s report on Form 10-Q forthe quarter ended September 30, 1995 (File No. 0-20164)].*

 

The Fountains

 

(10.30)            SubordinatedPromissory Note dated April 24, 1995 between CSM Fountains Limited Partnershipand Krupp Government Income Trust II [Exhibit 10.11 to Registrant’s report onForm 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].*

 

(10.31)            Agreement Re:Subordinated Note dated April 24, 1995 between Berkshire Mortgage FinanceCorporation and Krupp Government Income Trust II [Exhibit 10.12 to Registrant’sreport on Form 10-Q for the quarter ended September 30, 1995 (File No.0-20164)].*

 

(10.32)            SubordinatedMultifamily Mortgage Assignment of Rents and Security Agreement dated April 24,1995 between CSM Fountains Limited Partnership and Krupp Government IncomeTrust II [Exhibit 10.13 to Registrant’s report on Form 10-Q for the quarterended September 30, 1995 (File No. 0-20164)].*

 

RivergreensApartments

 

(10.33)            Mortgage Note datedAugust 19, 1993 between Rivergreens Associates II Limited Partnership and KruppMortgage Company Limited Partnership. [Exhibit 10.98 to Registrant’s report on Form 10-K for the year endedDecember 31, 1995 (File No. 0-20164)].*

 

(10.34)            SubordinatedPromissory Note, dated August 19, 1993, between Rivergreens Associates IILimited Partnership and Krupp Government Income Trust.  [Exhibit 10.99 to Registrant’s report onForm 10-K for the year ended December 31, 1995 (File No. 0-20164)].*

 

(10.35)            SubordinatedMultifamily Deed of Trust, Assignment of Rents and Security Agreement datedAugust 19, 1993 between Rivergreens Associates II Limited Partnership and KruppGovernment Income Trust II.  [Exhibit10.100 to Registrant’s report on Form 10-K for the year ended December 31, 1995(File No. 0-20164)].*

 

Mill Pond IIApartments

 

(10.36)            Mortgage Note datedJuly 26, 1994 for Mill Pond II Limited Partnership and Krupp Mortgage CompanyLimited Partnership.  [Exhibit 10.101 toRegistrant’s report on Form 10-K for the year ended December 31, 1995 (File No.0-20164)].*

 

(10.37)            MultifamilySubordinated Mortgage, Assignment of Rents and Security Agreement dated July26, 1994 between Mill Pond II Limited Partnership and Krupp Government IncomeTrust II. [Exhibit 10.102 to Registrant’s report on Form 10-K for the yearended December 31, 1995 (File No. 0-20164)].*

 

(10.38)            SubordinatedPromissory Note, dated July 26, 1994, between Mill Pond II Limited Partnershipand Krupp Government Income Trust. [Exhibit 10.103 to Registrant’s report on Form 10-K for the year endedDecember 31, 1995 (File No. 0-20164)].*

 

(10.39)            Agreement reSubordinated Note dated July 26, 1994, between Berkshire Mortgage FinanceCorporation and Krupp Government Income Trust. [Exhibit 10.104 to Registrant’s report on Form 10-K for the year endedDecember 31, 1995 (File No. 0-20164)].*

 

(99)                                                                                    Other

 

(99.1)                  Chairman of theBoard Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002. +

 

(99.2)                  Chief AccountingOfficer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002. +

 

----

* Incorporated byreference

+ Filed herewith

 

16

----

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15 (d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized, on the 14th day ofMarch, 2003.

 

 
|   | KRUPP GOVERNMENT INCOME  TRUST II |
|--------|-----------------------------------|
|   |                              |
|   |                              |
|   | By:                               |   / s /   Douglas Krupp |   |
|   |                              | Douglas Krupp, Chairman  of the Board of Trustees and a Trustee of Krupp Government Income Trust II |

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities indicated, on the 14th day of March, 2003.

 

 
| **Signatures**                |   | **Title(s)**                         |
|-------------------------------|--------|--------------------------------------|
|                          |   |                                 |
|  /s/ Douglas Krupp       |   |                                 | Chairman of the Board of  Trustees and a Trustee |
| Douglas Krupp                 |   | of Krupp Government  Income Trust II |
|                          |   |                                 |
|  /s/ Alan Reese          |   |                                 | Treasurer of Krupp  Government Income Trust II |
| Alan Reese                    |   |                                 |
|                          |   |                                 |
|  /s/ Charles N. Goldberg |   |                                 | Trustee of Krupp  Government Income Trust II |
| Charles N. Goldberg           |   |                                 |
|                          |   |                                 |
|  /s/ J. Paul Finnegan    |   |                                 | Trustee of Krupp  Government Income Trust II |
| J. Paul Finnegan              |   |                                 |
|                          |   |                                 |
|  /s/ Stephen Puleo       |   |                                 | Trustee of Krupp  Government Income Trust II |
| Stephen Puleo                 |   |                                 |
|                               |        |                                      |  |  |

 

17

----

 

Certifications

 

I, Douglas Krupp, certify that:

 

1.                     I havereviewed this annual report on Form 10-K of Krupp Government Income Trust II;

 

2.                     Based on myknowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3.                     Based on myknowledge, the financial statements, and other financial information includedin this annual report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this annual report;

 

4.                     Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a.                   designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisannual report is being prepared;

 

b.                  evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c.                   presented inthis annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                     Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a.                   all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.                  any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.                     The registrant’sother certifying officers and I have indicated in this annual report whetherthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date: March 14, 2003

 

 
|   | /s/ Douglas Krupp                                |   |
|--------|--------------------------------------------------|--------|
|   | Douglas Krupp                                    |   |
|   | Chairman of the Board  of Trustees and a Trustee |   |
|   | of Krupp Government  Income Trust II             |   |
|        |                                                  |        |  |

 

18

----

 

Certifications

 

I, Alan Reese, certify that:

 

1.                     I havereviewed this annual report on Form 10-K of Krupp Government Income Trust II;

 

2.                     Based on myknowledge, this annual report does not contain any untrue statement of amaterial fact or omit to   state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.                     Based on myknowledge, the financial statements, and other financial information includedin this annual report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this annual report;

 

4.                     Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a.                   designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which this annualreport is being prepared;

 

b.                  evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c.                   presented inthis annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                     Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a.                   all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.                  any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.                     Theregistrant’s other certifying officers and I have indicated in this annualreport whether there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: March 14, 2003

 
|   | /s/ Alan Reese                                 |   |
|--------|------------------------------------------------|--------|
|   | Alan Reese                                     |   |
|   | Treasurer of Krupp  Government Income Trust II |   |

 

19

----

 

APPENDIX A

 

KRUPP GOVERNMENTINCOME TRUST II

 

 

FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

ITEM 8 of FORM10-K

 

ANNUAL REPORT TOTHE SECURITIES AND EXCHANGE COMMISSION

For the Year EndedDecember 31, 2002

 

F-1

----

 

KRUPP GOVERNMENTINCOME TRUST II

 

INDEX TO FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 
| Report of Independent  Accountants                                                                                                                             | F - 3          |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------|
|                                                                                                                                                           |           |
| Balance Sheets at December 31, 2002 and  2001                                                                                                                  | F - 4          |
|                                                                                                                                                           |           |
| Statements  of Income and Comprehensive Income for the Years Ended December 31, 2002,  2001 and 2000                                                           | F - 5          |
|                                                                                                                                                           |           |
| Statements  of Changes in Shareholders’ Equity for the Years Ended December 31, 2002,  2001 and 2000                                                      | F - 6          |
|                                                                                                                                                           |           |
| Statements  of Cash Flows for the Years Ended December 31, 2002, 2001and 2000                                                                                  | F - 7          |
|                                                                                                                                                           |           |
| Notes to Financial  Statements                                                                                                                                 | F - 8 - F - 19 |
|                                                                                                                                                           |           |
| Schedule  II – Valuation and Qualifying Accounts                                                                                                          | F - 20         |
|                                                                                                                                                           |           |
| Supplementary  Data - Selected Quarterly Financial Data (Unaudited)                                                                                            | F - 21         |
|                                                                                                                                                           |           |
| All other schedules are  omitted as they are not applicable or not required, or the information is  provided in the financial statements or the notes thereto. |           |

 

F-2

----

 

REPORT OF INDEPENDENTACCOUNTANTS

 

 

To the Board of Trusteesand Shareholders of

Krupp Government IncomeTrust II:

 

In our opinion, the financial statements listed in the accompanyingindex present fairly, in all material respects, the financial position of KruppGovernment Income Trust II (the “Trust”) at December 31, 2002 and 2001, and theresults of its operations and its cash flows for each of the three years in theperiod ended December 31, 2002 in conformity with accounting principlesgenerally accepted in the United States of America.  In addition, in our opinion, the financial statement schedulelisted in the accompanying index presents fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedfinancial statements.  These financialstatements and financial statement schedule are the responsibility of theTrust’s management; our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits. Weconducted our audits of these statements in accordance with auditing standardsgenerally accepted in the United States of America, which require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

 

PricewaterhouseCoopersLLP

Boston, Massachusetts

March 14, 2003

 

F-3

----

 

KRUPP GOVERNMENTINCOME TRUST II

 

BALANCE SHEETS

 

December 31, 2002and 2001

 
|                                                                                                                        |   | **2002**    |        | **2001**    |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-------------|--------|
|                                                                                                                        |   |        |        |        |   |
| ASSETS                                                                                                                      |   |        |        |        |   |
|                                                                                                                        |   |        |        |        |   |
| Participating Insured Mortgage Investments (“PIMIs”)(Notes B, C, I  and J)  Insured mortgages                     |   | $           | 49,641,101  |        | $      | 85,625,185 |   |
| Additional loans, net of impairment provision of $0 and $500,000,  respectively                                             |   | 11,754,000  |        | 17,654,500  |   |
| Participating Insured Mortgages (“PIMs”) (Notes B, D and I)                                                       |   | 36,817,984  |        | 37,239,922  |   |
| Mortgage-Backed Securities (“MBS”) (Notes B, E and I)                                                             |   | 11,521,401  |        | 15,600,964  |   |
|                                                                                                                        |   |        |        |        |   |
| Total mortgage investments                                                                                                  |   | 109,734,486 |        | 156,120,571 |   |
|                                                                                                                        |   |        |        |        |   |
| Cash  and cash equivalents (Notes B and I)                                                                                  |   | 20,450,923  |        | 6,453,663   |   |
| Interest  receivable and other assets                                                                                       |   | 893,646     |        | 1,174,106   |   |
| Prepaid acquisition fees and expenses, net of accumulated  amortization of $6,479,558 and $7,964,938, respectively (Note B) |   | 1,286,992   |        | 2,913,250   |   |
| Prepaid participation servicing fees, net of accumulated amortization  of $1,991,606 and $2,420,697, respectively (Note B)  |   | 494,352     |        | 1,102,473   |   |
|                                                                                                                        |   |        |        |        |   |
| Total assets                                                                                                                |   | $           | 132,860,399 |        | $      | 167,764,063 |   |
|                                                                                                                        |   |        |        |        |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                  |   |        |        |        |   |
|                                                                                                                        |   |        |        |        |   |
| Deferred income on Additional Loans (Note B)                                                                                |   | $           | —      |        | $      | 1,242,282 |   |
| Other liabilities                                                                                                           |   | 47,848      |        | 25,985      |   |
|                                                                                                                        |   |        |        |        |   |
| Total liabilities                                                                                                           |   | 47,848      |        | 1,268,267   |   |
|                                                                                                                        |   |        |        |        |   |
| Shareholders’ equity (Notes A and F)                                                                                   |   |        |        |        |   |
| Common stock, no par value; 25,000,000 Shares authorized; 18,371,477  Shares issued and outstanding                         |   | 132,302,504 |        | 166,214,677 |   |
|                                                                                                                        |   |        |        |        |   |
| Accumulated comprehensive income (Notes B and E)                                                                            |   | 510,047     |        | 281,119     |   |
|                                                                                                                        |   |        |        |        |   |
| Total Shareholders’ equity                                                                                             |   | 132,812,551 |        | 166,495,796 |   |
|                                                                                                                        |   |        |        |        |   |
| Total liabilities and Shareholders’ equity                                                                             |   | $           | 132,860,399 |        | $      | 167,764,063 |   |

 

The accompanyingnotes are an integral

part of thefinancial statements.

 

F-4

----

 

KRUPP GOVERNMENTINCOME TRUST II

 

STATEMENTS OF INCOME ANDCOMPREHENSIVE INCOME

 

For the YearsEnded December 31, 2002, 2001, and 2000

 
|                                                                |   | **2002**   |       | **2001**   |   | **2000**   |   |
|---------------------------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
| Revenues:                                                           |   |       |       |       |   |       |   |
| Interest income - PIMs and PIMIs:                                   |   |       |       |       |   |       |   |
| Basic interest                                                      |   | $          | 6,873,359  |       | $      | 9,673,656  |   | $ | 11,259,617 |   |
| Additional Loan interest                                            |   | 2,911,978  |       | 2,207,942  |   | 1,783,933  |   |
| Participation interest                                              |   | 6,427,684  |       | 11,873,054 |   | 1,915,557  |   |
| Interest income – MBS                                          |   | 859,519    |       | 1,197,120  |   | 1,455,367  |   |
| Interest income – cash and cash equivalents                    |   | 286,099    |       | 378,045    |   | 563,723    |   |
|                                                                |   |       |       |       |   |       |   |
| Total revenues                                                      |   | 17,358,639 |       | 25,329,817 |   | 16,978,197 |   |
|                                                                |   |       |       |       |   |       |   |
| Expenses:                                                           |   |       |       |       |   |       |   |
| Asset management fee to an affiliate (Note G)                       |   | 943,476    |       | 1,309,430  |   | 1,529,418  |   |
| Expense reimbursements to affiliates (Note G)                       |   | 219,194    |       | 267,554    |   | 300,348    |   |
| Amortization of prepaid fees and expenses (Note B)                  |   | 2,234,379  |       | 2,607,681  |   | 2,131,748  |   |
| General and administrative (Note G)                                 |   | 424,208    |       | 504,174    |   | 385,879    |   |
| Reduction of provision for impaired additional loan (Notes B and C) |   | (500,000   | )          | (1,500,000 | )      | (994,000   | )      |
|                                                                |   |       |       |       |   |       |   |
| Total expenses                                                      |   | 3,321,257  |       | 3,188,839  |   | 3,353,393  |   |
|                                                                |   |       |       |       |   |       |   |
| Net income (Notes B and H)                                          |   | 14,037,382 |       | 22,140,978 |   | 13,624,804 |   |
|                                                                |   |       |       |       |   |       |   |
| Other comprehensive income:                                         |   |       |       |       |   |       |   |
|                                                                |   |       |       |       |   |       |   |
| Net change in unrealized gain on MBS                                |   | 228,928    |       | 199,818    |   | 635,251    |   |
|                                                                |   |       |       |       |   |       |   |
| Total comprehensive income                                          |   | $          | 14,266,310 |       | $      | 22,340,796 |   | $ | 14,260,055 |   |
|                                                                |   |       |       |       |   |       |   |
| Basic earnings per Share                                            |   | $          | .76        |       | $      | 1.21       |   | $ | .74 |   |
|                                                                |   |       |       |       |   |       |   |
| Weighted average Shares outstanding                                 |   | 18,371,477 |       | 18,371,477 |   | 18,371,477 |   |

 

The accompanyingnotes are an integral

part of the financialstatements.

 

F-5

----

 

KRUPP GOVERNMENTINCOME TRUST II

 

STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITY

 

For the YearsEnded December 31, 2002, 2001 and 2000

 
|                             |   | **Common  Stock** | ** **  | **Retained  Earnings** |   | **Accumulated  Comprehensive  Income (Loss)** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|----------------------------------|--------|-------------------|-------------|------------------------|--------|-----------------------------------------------|------------|---------------------------------------|------------|
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Balance at December 31, 1999     |   | $                 | 228,920,012 |                   | $      | —                                        |       | $                                     | (553,950   | ) | $ | 228,366,062 |   |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Dividends                        |   | (16,136,989       | )           | (13,624,804            | )      | —                                        |       | (29,761,793                           | )          |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Net income                       |   | —            |        | 13,624,804             |   | —                                        |       | 13,624,804                            |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Change in unrealized gain on MBS |   | —            |        | —                 |   | 635,251                                       |       | 635,251                               |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Balance at December 31, 2000     |   | 212,783,023       |        | —                 |   | 81,301                                        |       | 212,864,324                           |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Dividends                        |   | (46,568,346       | )           | (22,140,978            | )      | —                                        |       | (68,709,324                           | )          |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Net income                       |   | —            |        | 22,140,978             |   | —                                        |       | 22,140,978                            |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Change in unrealized gain on MBS |   | —            |        | —                 |   | 199,818                                       |       | 199,818                               |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Balance at December 31, 2001     |   | 166,214,677       |        | —                 |   | 281,119                                       |       | 166,495,796                           |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Dividends                        |   | (33,912,173       | )           | (14,037,382            | )      | —                                        |       | (47,949,555                           | )          |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Net income                       |   | —            |        | 14,037,382             |   | —                                        |       | 14,037,382                            |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Change in unrealized gain on MBS |   | —            |        | —                 |   | 228,928                                       |       | 228,928                               |       |
|                             |   |              |        |                   |   |                                          |       |                                  |       |
| Balance at December 31, 2002     |   | $                 | 132,302,504 |                   | $      | —                                        |       | $                                     | 510,047    |   | $ | 132,812,551 |   |

 

Shares issued andoutstanding for each of the three years in the period ended December 31, are18,371,477.

 

The accompanyingnotes are an integral

part of thefinancial statements.

 

F-6

----

 

KRUPP GOVERNMENTINCOME TRUST II

 

STATEMENTS OF CASH FLOWS

 

For the YearsEnded December 31, 2002, 2001 and 2000

 
|                                                                               |   | **2002**    |       | **2001**    |   | **2000**    |   |
|------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|-------------|--------|
|                                                                               |   |        |       |        |   |        |   |
| Operating activities:                                                              |   |        |       |        |   |        |   |
| Net income                                                                         |   | $           | 14,037,382 |        | $      | 22,140,978  |   | $ | 13,624,804 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |   |        |       |        |   |        |   |
| Amortization  of net premium                                                       |   | 74,010      |       | 75,585      |   | 58,017      |   |
| Amortization  of prepaid fees and expenses                                         |   | 2,234,379   |       | 2,607,681   |   | 2,131,748   |   |
| Reduction  of provision for impaired additional loans                              |   | (500,000    | )          | (1,500,000  | )      | (994,000    | )      |
| Changes  in assets and liabilities:                                                |   |        |       |        |   |        |   |
| Decrease in interest receivable and other assets                                   |   | 280,460     |       | 378,462     |   | 76,981      |   |
| Decrease in deferred income on Additional Loans                                    |   | (1,242,282  | )          | (1,261,322  | )      | (189,372    | )      |
| Increase (decrease) in other liabilities                                           |   | 21,863      |       | (127,288    | )      | 3,248       |   |
|                                                                               |   |        |       |        |   |        |   |
| Net cash provided by operating activities                                          |   | 14,905,812  |       | 22,314,096  |   | 14,711,426  |   |
|                                                                               |   |        |       |        |   |        |   |
| Investing activities:                                                              |   |        |       |        |   |        |   |
| Principal collections on MBS                                                       |   | 4,234,205   |       | 3,647,045   |   | 2,580,441   |   |
| Principal collections on Additional Loans                                          |   | 6,400,500   |       | 6,137,851   |   | —      |   |
| Principal collections on PIMs and Insured Mortgages                                |   | 36,406,298  |       | 35,974,542  |   | 10,905,706  |   |
|                                                                               |   |        |       |        |   |        |   |
| Net cash provided by investing activities                                          |   | 47,041,003  |       | 45,759,438  |   | 13,486,147  |   |
|                                                                               |   |        |       |        |   |        |   |
| Financing activity:                                                                |   |        |       |        |   |        |   |
| Dividends                                                                          |   | (47,949,555 | )          | (68,709,324 | )      | (29,761,793 | )      |
|                                                                               |   |        |       |        |   |        |   |
| Net  increase (decrease) in cash and cash equivalents                              |   | 13,997,260  |       | (635,790    | )      | (1,564,220  | )      |
|                                                                               |   |        |       |        |   |        |   |
| Cash and cash equivalents, beginning of period                                     |   | 6,453,663   |       | 7,089,453   |   | 8,653,673   |   |
|                                                                               |   |        |       |        |   |        |   |
| Cash and cash equivalents, end of period                                           |   | $           | 20,450,923 |        | $      | 6,453,663   |   | $ | 7,089,453 |   |
|                                                                               |   |        |       |        |   |        |   |
| Non cash activities:                                                               |   |        |       |        |   |        |   |
| Increase in Fair Value of MBS                                                      |   | $           | 228,928    |        | $      | 199,818     |   | $ | 635,251 |   |

 

The accompanyingnotes are an integral

part of thefinancial statements.

 

F-7

----

 

KRUPP GOVERNMENTINCOME TRUST II

 

NOTES TO FINANCIALSTATEMENTS

 

A.            Organization

 

Krupp GovernmentIncome Trust II (the “Trust”) was formed on February 8, 1991 by filing a Declarationof Trust in The Commonwealth of Massachusetts. The Trust is authorized to selland issue not more than 25,000,000 shares of beneficial interest (the“Shares”).  The Trust was organized forthe purpose of investing in commercial and multi-family loans and mortgagebacked securities.  Berkshire MortgageAdvisors Limited Partnership (the “Advisor”) acquired 10,000 of such Shares for$200,000 and 18,315,158 Shares were sold for $365,686,058 net of purchasevolume discounts of $617,102 under a public offering which commenced onSeptember 11, 1991 and was completed on February 12, 1993.  Under the Dividend Reinvestment Plan(“DRP”), 46,319 Shares were sold for $880,061. The Trust shall terminate on December 31, 2030, unless earlierterminated by the affirmative vote of holders of a majority of the outstandingShares entitled to vote thereon.

 

B.            SignificantAccounting Policies

 

The Trust uses thefollowing accounting policies for financial reporting purposes:

 

Basis ofPresentation

 

The accompanyingfinancial statements have been prepared on the accrual basis of accounting inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”).

 

MBS

 

The Trust, inaccordance with the Financial Accounting Standards Board’s Statement No. 115,“Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”),classifies its MBS portfolio as available-for-sale. The Trust classifies itsMBS portfolio as available-for-sale as a portion of the MBS portfolio mayremain after all of the PIMs and PIMIs payoff and it will then be necessary tosell the remaining MBS portfolio in order to close out the Trust.  In addition, other situations such asliquidity needs could arise which would necessitate the sale of a portion ofthe MBS portfolio.  The Trust carriesits MBS at fair market value and reflects any unrealized gains (losses) as aseparate component of Shareholders’ Equity. The Trust amortizes purchase premiums or discounts over the life of theunderlying mortgages using the effective interest method.

 

## PIMs and PIMIs

 

The Trust accountsfor its MBS portion of a PIM or PIMI investment in accordance with FAS 115under the classification of held to maturity as these investments have aparticipation feature.  As a result, theTrust would not sell or otherwise dispose of the MBS.  Accordingly, the Trust has both the intention and ability to holdthese investments to expected maturity. The Trust carries these MBS atamortized cost.

 

The insuredmortgage portion of the Federal Housing Administration (“FHA”) PIM or PIMI iscarried at amortized cost.  The Trustholds these mortgages at amortized cost since they are fully insured by theFHA.

 

The AdditionalLoans are carried at amortized cost unless the Advisor believes there is animpairment in value, in which case a valuation allowance is established inaccordance with FAS 114 “Accounting by Creditors for Impairment of a Loan” andFAS 118 “Accounting by Creditors for Impairment of a Loan – Income Recognitionand Disclosures”.

 

Basic interest isrecognized based on the stated rate of the Department of Housing and UrbanDevelopment (“HUD”) Insured Mortgage loan (less the servicer’s fee) or the coupon rate of the Fannie Mae MBS.  The Trust recognizes interest related to theparticipation features when the amount becomes fixed and the transaction thatgives rise to such amount is finalized, cash is received and all contingenciesare resolved. This could be the sale or refinancing of the underlying realestate which results in a cash payment to the Trust or a cash payment made tothe Trust from surplus cash relative to the participation feature.  The Trust defers the recognition ofAdditional

 

F-8

----

 

Loan interestpayments as income to the extent these interest payments are from escrowsestablished with the proceeds of the Additional Loan.

 

When theproperties underlying the PIMIs generate sufficient cash flow to make therequired Additional Loan interest payments and the Additional Loan value is deemedcollectible, the Trust recognizes income as earned and commences amortizingdeferred interest amounts into income over the remaining estimated term of theAdditional Loan. During periods where mortgage loans are impaired the Trustsuspends amortizing deferred interest.

 

The Trust alsofully reserves the portion of any Additional Loan interest payment satisfiedthrough the issuance of an operating loan and any associated interest due onsuch operating loan.  The Trust willrecognize the income related to the operating loan when the borrower repaysamounts due under the operating loan.

 

#### Impaired Mortgage Loans

 

Impaired loans arethose Additional Loans for which the Advisor believes the collection of allamounts due in accordance with the contractual terms of the loan agreement isnot likely.  Impaired loans are measuredbased on the fair value of the underlying collateral net of estimated sellingcosts.  The Trust measures impairment onthese loans quarterly.  Interestreceived on impaired loans is generally applied against the loan principal.

 

#### Cash Equivalents

 

The Trust includesall short-term investments with maturities of three months or less from thedate of acquisition in cash and cash equivalents.  The Trust invests its cash primarily in agency paper, and moneymarket funds with a commercial bank and has not experienced any loss to date onits invested cash.

 

#### Prepaid Fees and Expenses

 

Prepaid fees andexpenses represent prepaid acquisition fees and expenses and prepaidparticipation servicing fees paid for the acquisition and servicing of PIMs andPIMIs.  The Trust amortizes prepaidacquisition fees and expenses using a method that approximates the effectiveinterest method over a period of ten to twelve years, which represents theestimated life of the underlying mortgage. The prepaid participation servicingfees are amortized using a method that approximates the effective interestmethod over a ten-year period beginning at final endorsement of the loan if aHUD-insured loan and at closing if a Fannie Mae loan.

 

Upon the repaymentof a PIM or PIMI, any unamortized acquisition fees and expenses and unamortizedparticipation servicing fees related to such loan are expensed.

 

#### Income Taxes

 

The Trust haselected to be taxed as a REIT under the Internal Revenue Code of 1986, asamended, and believes it will continue to meet all such qualifications.  Accordingly, the Trust will not be subjectto federal income taxes on amounts distributed to shareholders provided it distributesannually at least 90% of its REIT taxable income and meets certain otherrequirements for qualifying as a REIT. Therefore, no provision for federal income taxes has been recorded inthe financial statements.

 

F-9

----

 

### Estimates and Assumptions

 

The preparation offinancial statements in accordance with GAAP requires management to makeestimates and assumptions that affect the reported amount of assets andliabilities, contingent assets and liabilities and revenues and expenses duringthe period.  Significant estimatesinclude the net carrying value of Additional Loans and the unrealized gain onMBS investments.  Actual results coulddiffer from those estimates.

 

C.            PIMIs

 

The Trust had investments in four PIMIs at December31, 2002 and seven at December 31, 2001 that provide or provided the permanentfinancing for multi-family housing. Each remaining PIMI consists of a Fannie Mae MBS and an “AdditionalLoan” made to the borrower to provide additional funds for the construction orpermanent financing of the property. The first mortgage underlying the Fannie Mae MBS provided the borrowerwith a below market interest rate loan, and in return, the Trust receives apercentage of the cash generated from the property operations and a percentageof any appreciation thereafter (collectively the “participation interest”).

 

The borrower conveys the participation features to theTrust through the Additional Loan on a Fannie Mae PIMI. The Trust makes theAdditional Loan under the Fannie Mae PIMIs directly to the borrower of thefirst mortgage loan underlying the Fannie Mae MBS, and the borrowercollateralizes the Additional Loan with a subordinated mortgage on theproperty. The owners of the borrower also pledge their ownership interests inthe borrower as additional collateral.

 

The Trust receives level monthly payments of principaland interest payments, amortizing over thirty years on the Fannie Mae MBS.  While principal and interest payments on theFannie Mae MBS are guaranteed, there are limitations to the amount andobligation to pay interest under the Additional Loan.  As such amounts due under the Additional Loan are neither insurednor guaranteed.

 

The Additional Loans for Fannie Mae PIMIs entitle theTrust to receive (i) semi-annual interest payments on the Additional Loanprincipal, (ii) Participating Income Interest, (iii) Participating AppreciationInterest and (iv) Preferred Interest. Additional Loan interest accrues at the stated interest rate on the AdditionalLoan and Participating Income Interest represents the Trust’s share of the netrevenue generated by the property at a stated percentage generally ranging from25% to 35%.  Additional Loan interestand Participating Income Interest are payable only to the extent there is netrevenue available to pay these amounts. However, should the borrower be unableto make the full Additional Loan interest payment, the borrower must notify theTrust of the amount of the shortfall.

 

The Trust can require the partners of the borrower tomake a capital contribution to the borrower to fund 50% of this shortfall, andthe Trust will fund the remainder with an Operating Loan.  Also, the Trust is generally limited toreceiving no more than 50% of net revenue on any semi-annual payment date.Participating Appreciation Interest provides the Trust with a statedpercentage, ranging from 25% to 30%, of the excess value of the property overamounts due under the first mortgage, Additional Loan and any Operating Loans,the repayment of capital contributions, and a return of original equity to thepartners of the borrower.

 

Participating Appreciation Interest is due upon thesale, refinancing, maturity or accelerated maturity, or permitted prepayment ofall amounts due under the insured mortgage and Additional Loan.  Generally, the Trust will not receive morethan 50% of the excess of value over the outstanding indebtedness, the paymentof Preferred Interest, and the return of equity and capital contributions tothe partners of the borrower.

 

Preferred Interest refers to a non-compoundedcumulative return from the closing date of the loan to the date of calculation,at a stated interest rate generally on the original outstanding balance of theinsured mortgage plus the Additional Loan and any other funds advanced to the borrower(reduced by principal payments received) less: (i)

 

F-10

----

 

interest payments on the insured mortgage, (ii)Additional Loan interest, (iii) Participating Income Interest, and (iv)Participating Appreciation Interest.

 

Generally, the amount of Preferred Interest owedcannot exceed the excess of value over the outstanding indebtedness.  Amounts due under the Additional Loan arenot guaranteed.

 

The Fannie Mae PIMIs have maturities of 15 years,however, the Trust can accelerate the maturity dates at any time after theninth or tenth anniversary of the closing date of the Fannie Mae PIMIs, upongiving twelve months written notice for the payment.

 

If the Trust accelerates the maturity date, the Trustcan require payment of all amounts due under the Additional Loan through theaccelerated maturity date and prepayment of the first mortgage loan underlyingthe Fannie Mae MBS.

 

Fannie Mae PIMIs generally cannot be prepaid duringthe five years following the closing date of the underlying first mortgageloan.  Thereafter, the Fannie Mae firstmortgage loan may be prepaid subject to a prepayment penalty that declines eachyear for the next five years with no prepayment penalty after the tenthyear.  Any prepayment of a Fannie MaePIMI generally requires prepayment of the first mortgage loan underlying theFannie Mae MBS and payment of amounts due under the Additional Loan.  The Fannie Mae first mortgage loan would notneed to be prepaid if there is a permitted assumption of the first mortgageloan, however, amounts due under the Additional Loan would need to beprepaid.  Any prepayment usuallyrequires not less than 90 nor more than 180 days prior written notice.

 

Previously, the Trust also had FHA PIMIs whichconsisted of a 100% interest in a HUD insured first mortgage loan, anAdditional Loan and a subordinated promissory note.

 

The Trust made the Additional Loans on the FHA PIMIsto the owners of the entity having the FHA first mortgage loan, and the ownerscollateralized the Additional Loan by pledging their ownership interests in theborrowing entity, their share of any distributions received, and the proceedsrealized upon the refinancing of the property, sale of the property or sale ofthe partnership interests.

 

The Additional Loan and subordinated promissory noteon the FHA PIMI provided for participation features similar to those of theFannie Mae PIMIs.  Unlike the HUDinsured first mortgage loan, the Additional Loan and the subordinatedpromissory note were not insured.

 

On November 25, 2002, the Trustreceived $4,488,878, as a result of the payoff of the Sunset Summit AdditionalLoan. The payoff consisted of $1,900,000 for the principal due on theAdditional Loan, base interest of $33,250, Preferred Interest of $1,532,498 andParticipating Appreciation Interest of $1,023,130. On December 26, 2002, theTrust received $9,094,934 in proceeds from the Fannie Mae MBS related toSunset.  During the first half of 2003the Trust will pay a special dividend of $.74 per share from the prepayment ofthe Sunset Summit PIMI.

 

On March 28, 2002, the Trust received a prepayment ofthe Windmill Lakes Subordinated Promissory Note and the Windmill LakesAdditional Loan.  The Trust received$2,000,000 of Additional Loan principal and $162,500 of Additional Loaninterest.  As a result of the payoff,the Trust recognized $562,500 of Additional Loan interest which had beenreceived in prior years and was recorded as a reduction of the impaired AdditionalLoan.  As the entire Additional Loanprincipal balance of $2,000,000 was paid in 2002, the remaining impairmentprovision of $500,000 was also reversed. On April 25, 2002, the Trust received$10,727,382 in principal proceeds on the first mortgage note from WindmillLakes.  The Trust paid a specialdividend of $.71 per share from the proceeds of the Windmill Lakes prepaymenton May 1, 2002.

 

On July 25, 2001, the Trust finalized an agreementwith the owner of the Windmill Lakes property which allowed for the release ofthe participation features on the PIMI in the event that the first mortgage,the Additional Loan

 

F-11

----

 

and any accrued but unpaid base interest on theAdditional Loan were repaid by September 1, 2002. In addition, the Trustrequired the owner to pay current and outstanding Additional Loan base interestas of March 1, 2001 of $512,500.  As aresult of the performance of the property, the Trust had initially establisheda valuation allowance of $2,000,000 on the Additional Loan in 1998.  The Trust reflected $512,500 received plus$50,000 previously received as a reduction in the principal balance of theAdditional Loan and related impairment provision. Additionally, based uponimproved market conditions and property operations, the Trust had furtherreduced the impairment provision by $937,500 to $500,000 at December 31, 2001.

 

On February 13, 2002, the Trust received a prepaymentof the Norumbega Pointe Subordinated Promissory Note and the Norumbega PointeAdditional Loan.  The Trust received$3,063,000 of Additional Loan principal, $302,877 of Shared AppreciationInterest and $2,280,362 of Preferred Interest. On February 25, 2002, the Trust received $15,123,167 representing theprincipal proceeds on the first mortgage note. In addition, the Trust recognized $1,242,282 of Additional Loan interestthat had been previously received and recorded as deferred income on theAdditional Loan.  The Trust paid aspecial dividend of $1.14 per share from the proceeds of the Norumbega Pointeprepayment on March 12, 2002.

 

On July 23, 2001, the Trust received a prepayment ofthe Seasons Subordinated Promissory Note and the Seasons Additional Loan.  The Trust received $4,925,351 of theAdditional Loan principal, $462,983 of surplus cash, $2,168,701 of PreferredInterest, $2,693,326 of contingent interest, $176,908 of Base Interest onAdditional Loan and $3,325,696 which represents the Trust’s portion of theresidual split.  The Trust received$21,926,006 representing the principal proceeds on the first mortgage note onJuly 26, 2001.  In addition, the Trustrecognized $624,023 of Additional Loan interest that had been previouslyreceived and recorded in deferred income on Additional Loans.  The Advisor paid a special dividend of $1.95per share on August 17, 2001 from the proceeds of the Seasons PIMI prepayment.

 

The payoff of the Seasons PIMI was a result of thesale of the underlying property by the borrower, Maryland Associates LimitedPartnership (“MALP”), which is an affiliate of the Adviser, to an affiliate ofMALP’s general partner.  Because thesale of the underlying property was to an affiliate, the Independent Trusteesof the Trust were required to approve the transaction, which they did based upona number of factors, including an appraisal of the underlying property preparedby an independent third party MAI appraiser. The purchase price paid by the affiliate for the underlying property was$1.6 million greater than the value indicated by such appraisal.  Both the Trustees and the Advisor believedthat the market capitalization rate utilized in the appraisal was too highbased on their knowledge of recent sales in the market and agreed that the truefair value was the ultimate purchase price paid by the affiliate.

 

During the first quarter of 2001, the Trust received apayoff of the Hunters Pointe PIMI.  TheTrust received the outstanding balance on the insured mortgage of $12,347,267,the outstanding balance on the Additional Loan of $650,000, ParticipatingIncome Interest of $496,207 (including all of the delinquent amounts),Preferred Interest of $492,543, Participating Appreciation Interest of$1,070,304 and late fees on the delinquent Participating Income Interest of$11,021.  In addition, the Trustrecognized $196,710 of Additional Loan interest and $311,132 of ParticipatingIncome Interest that had been previously received and recorded in deferredincome on Additional Loans.  On March20, 2001, the Trust paid a special dividend of $.83 per share from the proceedsof the Hunters Pointe PIMI payoff.

 

At December 31, 2002 and 2001 there are no PIMIswithin the Trust’s portfolio that are delinquent as to principal or interest.

 

F-12

----

 

TheTrust’s investments in PIMIs consists of the following at December 31, 2002 and2001:

 
| **Insured  Mortgages** |   | **Loan  Amount** | ** ** | **Approximate  Monthly  Payments** | ** ** | **Interest  Rate** | ** ** | **Maturity  Date** | ** ** | **Balance  Outstanding at December 31,** | ** ** |
|------------------------|--------|------------------|------------|------------------------------------|------------|--------------------|------------|--------------------|------------|------------------------------------------|------------|
| **2002**               |   | **2001**         |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| FHA                    |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| Norumbega  Point       |   | $                | 15,598,500 |                               | $          | —             |       | —             |       | —                                   |       | $ | — |   | $ | 15,139,275 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| FNMA(a)                |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| Crossings  Village     |   | 12,907,334       |       | 82,800                             |       | 6.75               | %          | 10/01/08           |       | 11,516,017                               |       | 11,722,936 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| Martin’s  Landing |   | 11,200,000       |       | 69,800                             |       | 6.50               | %          | 12/01/08           |       | 9,970,854                                |       | 10,153,225 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| Sunset  Summit         |   | 10,192,801       |       | —                             |       | —             |       | —             |       | —                                   |       | 9,246,686 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| Oasis                  |   | 12,401,673       |       | 79,300                             |       | 6.75               | %          | 09/01/09           |       | 11,247,702                               |       | 11,432,503 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| Windmill  Lakes        |   | 11,600,000       |       | —                             |       | —             |       | —             |       | —                                   |       | 10,767,647 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
| The  Lakes             |   | 18,387,653       |       | 118,400                            |       | 6.825              | %          | 07/01/10           |       | 16,906,528                               |       | 17,162,913 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   |   |
|                   |   | $                | 92,287,961 |                               | $          | 350,300            |       |               |       |                                     |       | $ | 49,641,101 |   | $ | 85,625,185 |   |
|                   |   |             |       |                               |       |               |       |               |       |                                     |       |   | (b) |   |   |   |   |

 
| **Additional Loans**  |   | **2002**  | ** ** | **2001**  | ** ** | **Maturity  Date** | ** ** | **Base  Interest  Rate** | ** ** | **Preferred  Interest  Rate** | ** ** |
|-----------------------|--------|-----------|------------|-----------|------------|--------------------|------------|--------------------------|------------|-------------------------------|------------|
| Norumbega Pointe      |   | $         | —     |      | $          | 3,063,000          |       | —                   |       | —                        |       | — |   |
| Crossings Village     |   | 2,584,000 |       | 2,584,000 |       | 10/01/08           |       | 7                        | %          | 9                             | %          |
| Martin’s Landing |   | 2,280,000 |       | 2,280,000 |       | 12/01/08           |       | 7                        | %          | 12                            | %          |
| Sunset Summit         |   | —    |       | 1,900,000 |       | —             |       | —                   |       | —                        |       |
| Oasis                 |   | 2,290,000 |       | 2,290,000 |       | 09/01/09           |       | 7                        | %          | 9.25                          | %          |
| Windmill Lakes (c):   |   |      |       |      |       |               |       |                     |       |                          |       |
| Due Contractually     |   | —    |       | 2,000,000 |       | —             |       | —                   |       | —                        |       |
| Interest applied      |   | —    |       | (562,500  | )          |               |       |                     |       |                          |       |
| Recorded Value        |   | —    |       | 1,437,500 |       |               |       |                     |       |                          |       |
| The Lakes             |   | 4,600,000 |       | 4,600,000 |       | 07/01/10           |       | 7                        | %          | 9                             | %          |
|                  |   |      |       |      |       |               |       |                     |       |                          |       |
|                  |   | $         | 11,754,000 |      | $          | 18,154,500         |       |                     |       |                          |       |   |   |
|                  |   |      | (c)        |      |       |               |       |                     |       |                          |       |   |   |

 

----

(a)                   Monthlyprincipal and interest payments are based on a 30-year amortization.  The unpaid principal balances due atmaturity are as follows:

 
| Crossings Village     |   | $ | 9,917,000  |   |
|-----------------------|--------|---|------------|--------|
| Martin’s Landing |   | $ | 8,524,000  |   |
| Oasis                 |   | $ | 9,550,000  |   |
| The Lakes             |   | $ | 14,118,000 |   |

 

F-13

----

 

 

(b)                  The aggregatecost for federal income tax purposes is $49,641,101.

 

(c)                   The aggregatecost for federal income tax purposes is $11,754,000.

 

###### Impaired AdditionalLoans

 

On December 31, 1998, as a result of continueddeterioration in property operations, the Advisor of the Trust determined thatthe Windmill Lakes Additional Loan was impaired. As a result, a valuationallowance of $2,000,000 was established to adjust the carrying amount of theloan to the estimated fair market value of the collateral less anticipatedcosts of sale.  On July 25, 2001, theTrust received $512,500 in accrued but unpaid base interest.  The Trust reflected the $512,500 receivedplus $50,000 previously received as a reduction in the principal balance of theAdditional Loan and related impairment provision. During the fourth quarter of2001, based on improved market conditions and property operations, the Trustreduced the impairment provision by an additional $937,500 to $500,000. As aresult of the payoff received in March 2002, the remaining impairment provisionof $500,000 was reversed.

 

On December 31, 1998, as a result of continueddeterioration in property operations, the Advisor of the Trust determined thatthe Oasis Additional Loan was impaired. As a result, a valuation allowance of$994,000 was established to adjust the carrying amount of the loan to theestimated fair market value of the collateral less anticipated costs ofsale.  During 2000, property operationsimproved and, as a result, the Advisor determined that the Oasis AdditionalLoan was no longer impaired.  Therefore,the valuation allowance was reversed.

 

Reconciliations of activity for 2002, 2001 and 2000are as follows:

 
| **Insured Mortgages**          |   | **2002**    |       | **2001**    |   | **2000**    |   |
|--------------------------------|--------|-------------|------------|-------------|--------|-------------|--------|
|                           |   |        |       |        |   |        |   |
| Balance at beginning of period |   | $           | 85,625,185 |        | $      | 121,208,064 |   | $ | 131,750,452 |   |
|                           |   |        |       |        |   |        |   |
| Principal collections          |   | (35,984,084 | )          | (35,582,879 | )      | (10,542,388 | )      |
|                           |   |        |       |        |   |        |   |
| Balance at end of period       |   | $           | 49,641,101 |        | $      | 85,625,185  |   | $ | 121,208,064 |   |
|                           |   |        |       |        |   |        |   |   |   |   |
|                           |   |        |       |        |   |        |   |   |   |   |

 
| **Additional Loans**                                           |   | **2002**   |       | **2001**   |   | **2000**   |   |
|----------------------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
|                                                           |   |       |       |       |   |       |   |
| Balance at beginning of period                                 |   | $          | 17,654,500 |       | $      | 22,292,351 |   | $ | 21,298,351 |   |
|                                                           |   |       |       |       |   |       |   |
| Interest received and recognized as Additional Loan prepayment |   | —     |       | (562,500   | )      | —     |   |
|                                                           |   |       |       |       |   |       |   |
| Additional Loan  prepayments                                   |   | (6,400,500 | )          | (5,575,351 | )      | —     |   |
|                                                           |   |       |       |       |   |       |   |
| Adjustment to valuation allowance                              |   | 500,000    |       | 1,500,000  |   | 994,000    |   |
|                                                           |   |       |       |       |   |       |   |
| Balance at end of period                                       |   | $          | 11,754,000 |       | $      | 17,654,500 |   | $ | 22,292,351 |   |

 

F-14

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Property Descriptions:

 

•       Crossings Village Apartments (“Crossings Village”) is a286-unit apartment complex located in Westlake, Ohio.

•       Martin’s Landing Apartments (“Martin’s Landing”) is a 300-unitapartment complex in Roswell, Georgia.

•       Oasis at Springtree (“Oasis”) is a 276-unit apartment complexlocated in Sunrise, Florida.

•       The Lakes atVinings Apartments (“The Lakes”) is a 464-unit garden and townhouse styleapartment complex in Vinings, Georgia.

 

D.            PIMS

 

The Trust has investments in four PIMs.  The Trust’s PIMs consist of either a FannieMae MBS or a sole participation interest in a HUD-insured first mortgage loanoriginated under the FHA lending program (collectively the “insured mortgages”)and participation interests in the revenue stream and appreciation of theproperty above specified levels.  Theborrower conveys these participation features to the Trust generally through asubordinated promissory note and mortgage (the “Agreement”).  The Trust receives level monthly principaland interest payments, amortized over thirty to forty years.  The Fannie Mae MBS is guaranteed by FannieMae, and HUD insures payment of principal and interest on the FHA firstmortgage loan.

 

The borrower generally cannot prepay the insuredmortgage during the first five years but may prepay it thereafter subject to a9% prepayment premium in years six through nine, a 1% prepayment premium inyear ten and no prepayment premium thereafter. The Trust may receive interestrelated to its participation interests in the underlying property, however,these amounts are neither insured nor guaranteed.  Generally, the participation features consist of thefollowing:  (i) “Minimum AdditionalInterest” at rates ranging from .5% to .75% per annum calculated on the unpaidprincipal balance of the first mortgage on the underlying property, (ii)“Shared Income Interest” ranging from 25% to 30% of the monthly gross rentalincome generated by the underlying property in excess of a specified base, butonly to the extent that it exceeds the amount of Minimum Additional Interestreceived during such month and (iii) “Shared Appreciation Interest” rangingfrom 25% to 30% of any increase in value of the underlying property in excessof a specified threshold.  Payment ofparticipation interest from the operations of the property is limited to 50% ofnet revenue or surplus cash as defined by Fannie Mae or HUD, respectively.  The total amount of participation interestpayable by the borrower generally cannot exceed 50% of any increase in value ofthe property.

 

Shared Appreciation Interest is payable when one ofthe following occurs: (1) the sale of the underlying property to an unrelatedthird party on a date which is later than five years from the date of theAgreement, (2) the maturity date of the Agreement, or (3) prepayment of theAgreement.

 

Under the Agreement, the Trust, upon giving twelvemonths written notice, can accelerate the maturity date of the Agreement andinsured mortgage to a date not earlier than ten years from the date of theAgreement for (a) the payment of all participation interest due under theAgreement as of the accelerated maturity date or (b) the payment of allparticipation interest due under the Agreement plus all amounts due on thefirst mortgage note on the property.

 

On December 30, 2002, the Trustreceived a prepayment of the Mequon Trails PIM participation feature totaling$572,226. The payoff consisted of$385,000 of Shared Appreciation Interest and $187,226 of Minimum AdditionalInterest and Shared Income Interest.  OnJanuary 27, 2003, the Trust received $13,007,834 in proceeds from the Fannie MaeMBS related to Mequon.  The Trust willmake a special dividend of $.74 per share from the proceeds of the MequonTrails PIM prepayment during the first half of 2003.

 

At December 31, 2002 and 2001 there are no insuredmortgage loans within the Trust’s portfolio that are delinquent of principal orinterest.

 

F-15

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The Trust’s PIMs consisted of thefollowing at December 31, 2002 and 2001:

 
| **PIM**        |   | **Original  Amount** |       | **Approximate  Monthly  Payments** |   | **Interest  Rate** |   | **Maturity  Date** |   | **Balance  Outstanding at December 31,** |   |
|----------------|--------|----------------------|------------|------------------------------------|--------|--------------------|--------|--------------------|--------|------------------------------------------|--------|
| **2002**       |   | **2001**             |
| FNMA           |   |                 |       |                               |   |               |   |               |   |                                     |   |   |   |
| Mequon Trails  |   | $                    | 14,937,726 |                               | $      | 93,700             |   | 6.50               | %      | 01/01/08                                 | (a)    | $ | 13,007,834 |   | $ | 13,276,440 |   |
|           |   |                 |       |                               |   |               |   |               |   |                                     |   |   |   |
| FHA            |   |                 |       |                               |   |               |   |               |   |                                     |   |   |   |
| Rivergreens II |   | 6,137,199            |       | 39,800                             |   | 7.375              | %      | 01/01/35           |   | 5,874,997                                |   | 5,917,280 |   |
|           |   |                 |       |                               |   |               |   |               |   |                                     |   |   |   |
| Mill Ponds II  |   | 8,245,300            |       | 51,900                             |   | 7.125              | %      | 12/01/35           |   | 7,926,183                                |   | 7,982,225 |   |
|           |   |                 |       |                               |   |               |   |               |   |                                     |   |   |   |
| The Fountains  |   | 10,336,000           |       | 70,800                             |   | 7.875              | %      | 11/01/36           |   | 10,008,970                               |   | 10,063,977 |   |
|           |   |                 |       |                               |   |               |   |               |   |                                     |   |   |   |
| Total          |   | $                    | 39,656,225 |                               | $      | 256,200            |   |               |   |                                     |   | $ | 36,817,984 | (b) | $ | 37,239,922 |   |

 

----

(a)             Principal andinterest payments are based on a 30-year amortization.  Unpaid principal of approximately$11,267,000 is due at maturity.

(b)            The aggregate cost forfederal income tax purposes is $36,817,984.

 

Reconciliationsof activity for 2002, 2001 and 2000 are as follows:

 
|                           |   | **2002** |       | **2001** |   | **2000**   |   |
|--------------------------------|--------|----------|------------|----------|--------|------------|--------|
|                           |   |     |       |     |   |       |   |
| Balance at beginning of period |   | $        | 37,239,922 |     | $      | 37,631,330 |   | $ | 37,994,412 |   |
|                           |   |     |       |     |   |       |   |
| Discount amortization          |   | 276      |       | 255      |   | 236        |   |
|                           |   |     |       |     |   |       |   |
| Principal collections          |   | (422,214 | )          | (391,663 | )      | (363,318   | )      |
|                           |   |     |       |     |   |       |   |
| Balance at end of period       |   | $        | 36,817,984 |     | $      | 37,239,922 |   | $ | 37,631,330 |   |

 

Property descriptions:

 

•       MequonTrails Townhomes (“Mequon Trails”) is a 246-unit apartment complex located inMequon, Wisconsin.

•       RivergreensII Apartments (“Rivergreens II”) is a 126-unit apartment complex in Gladstone,Oregon.

•       Mill PondsII Apartments (“Mill Ponds II”) is a 150-unit apartment complex in Bellbrook,Ohio.

•       TheFountains Apartments (“The Fountains”) is a 204-unit apartment complex in WestDes Moines, Iowa.

 

E.      MortgageBacked Securities

 

At December 31,2002 the Trust’s MBS portfolio had an amortized cost of $11,011,354 and grossunrealized gains of $510,047.  AtDecember 31, 2001, the Trust’s MBS portfolio had an amortized cost of$15,319,845 and gross unrealized gains of $281,119.  The MBS have maturities ranging from 2008 to 2031.

 

F-16

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| **Maturity Date** |   | **Fair Value** |       | **Unrealized  Gain** |   |
|-------------------|--------|----------------|------------|----------------------|--------|
|              |   |           |       |                 |   |
| 2003 – 2007  |   | $              | —     |                 | $      | — |   |
| 2008  – 2012 |   | 3,612,262      |       | 175,699              |   |
| 2013  – 2031 |   | 7,909,139      |       | 334,348              |   |
|              |   |           |       |                 |   |
| Total             |   | $              | 11,521,401 |                 | $      | 510,047 |   |

 

F.                   Shareholders’Equity

 

Under theDeclaration of Trust, and commencing with the initial closing of the publicoffering of Shares, the Trust has declared and paid dividends on a quarterlybasis.  During the period in which theTrust qualifies as a REIT, the Trust has and will pay quarterly dividendsaggregating at least 90% of taxable income on an annual basis to be allocatedto the shareholders, in proportion to their respective number of shares.

 

In order for theTrust to maintain its REIT status with respect to the requirements of Shareownership, the Declaration of Trust prohibits any investor from owning,directly or indirectly more than 9.80% of the outstanding Shares unless anexemption is granted by the Trustees and empowers the Trustees to refuse topermit any transfer of Shares which, in their opinion, would jeopardize thestatus of the Trust as a REIT.

 

G.     RelatedParty Transactions

 

Under the terms ofthe Advisory Service Agreement, the Advisor receives an Asset Management Feeequal to .75% per annum of the value of the Trust’s actual and committedinvested assets payable quarterly.

 

The Trust alsoreimburses affiliates of the Advisor for certain expenses incurred inconnection with maintaining the books and records of the Trust, the preparationand mailing of financial reports, tax information and other communications toinvestors and legal fees and expenses. Included in general and administrative expenses are legal fees andexpenses paid by the Trust to an affiliate. During the three years ended December 31, 2002, 2001 and 2000 these feestotaled $16,083, $6,276 and $1,533, respectively.

 

The Trust earnedor received $398,549 of base interest from The Seasons in 2001 and $443,282 in2000 (see Note C).  In addition, theTrust received $8,780,579 in 2001 and $446,574 in 2000 related to participatinginterest income.

 

H.     FederalIncome Taxes

 

The reconciliationof the income reported in the accompanying statement of income with the incomereported in the Trust’s 2002 federal income tax return follows:

 
| Net income per statement of income                                                      |   | $          | 14,037,382 |   |
|-----------------------------------------------------------------------------------------|--------|------------|------------|--------|
|                                                                                    |   |       |       |
| Less:   Book to tax difference  for amortization of prepaid fees and expenses |   | (875,862   | )          |
|                                                                                    |   |       |       |
| Less:   Book to tax difference  for Additional Loan interest income           |   | (2,062,277 | )          |
|                                                                                    |   |       |       |
| Less:   Reduction of provision  for impaired mortgage loans                   |   | (500,000   | )          |
|                                                                                    |   |       |       |
| Net income for federal income tax purposes                                              |   | $          | 10,599,243 |   |

 

F-17

----

 

The Trust paiddividends of $2.61 per share during 2002 which represents approximately $.58from ordinary income and $2.03 represents a non-taxable dividend for federalincome tax purposes.

 

The basis of theTrust’s assets for financial reporting purposes is less than its tax basis byapproximately $4,237,000 and $7,162,000 at December 31, 2002 and 2001,respectively.  The basis of the Trust’sliabilities for financial reporting purposes were the same as its tax basis atDecember 31, 2002 and exceeded its tax basis by approximately $1,242,000 atDecember 31, 2001.

 

I.                    FairValue Disclosures of Financial Instruments

 

The Trust uses thefollowing methods and assumptions to estimate the fair value of each class offinancial instrument:

 

Cash and CashEquivalents

 

The carryingamount approximates fair value because of the short maturity of thoseinstruments.

 

MBS

 

The Trustestimates the fair value of MBS based on quoted market prices.  Based on the estimated fair value determinedusing these methods and assumptions, the Trust’s investments in MBS had grossunrealized gains of approximately $510,000 at December 31, 2002 and grossunrealized gains of approximately $281,000 at December 31, 2001.

 

PIMs and PIMIs

 

There is noestablished trading market for these investments.  Management estimates the fair value of the PIMs and the insuredmortgage portion of the PIMIs using quoted market prices of MBS having the samestated coupon rate as the insured mortgages. Additional Loans are based on the lower of the estimated collectionvalue of the loan based on the estimated fair value of the underlyingproperties or the remaining principal balance of the loan as an estimate of thefair value of the loan is not practicable. Management does not include any participation income in the Trust’sestimated fair values, as Management does not believe it can predict the timeof realization of the feature with any certainty.

 

Based on theestimated fair value determined using these methods and assumptions, theTrust’s investments in PIMs and PIMIs had gross unrealized gains ofapproximately $3,694,000 at December 31, 2002 and gross unrealized gains ofapproximately $1,777,000 at December 31, 2001.

 

At December 31,2002 and 2001, the estimated fair values of the Trust’s financial instrumentsare as follows:

 
|                      |   | **(rounded  to thousands)** |    |
|---------------------------|--------|-----------------------------|---------|
|                      |   | **2002**                    |    | **2001** |   |
|                      |   | **Fair  Value**             |    | **Carrying  Value** |   | **Fair  Value** |   | **Carrying  Value** |   |
|                      |   |                        |    |   |   |   |   |   |   |
| Cash and cash equivalents |   | $                           | 20,451  |   | $ | 20,451 |   | $ | 6,454 |   | $ | 6,454 |   |
|                      |   |                        |    |   |   |   |   |   |   |
| MBS                       |   | 11,521                      |    | 11,521 |   | 15,601 |   | 15,601 |   |
|                      |   |                        |    |   |   |   |   |   |   |
| PIMs and PIMIs:           |   |                        |    |   |   |   |   |   |   |
| PIMs                      |   | 38,345                      |    | 36,818 |   | 37,978 |   | 37,240 |   |
| Insured mortgages         |   | 51,808                      |    | 49,641 |   | 86,664 |   | 85,625 |   |
| Additional loans          |   | 11,754                      |    | 11,754 |   | 17,655 |   | 17,655 |   |
|                      |   |                        |    |   |   |   |   |   |   |
| Total                     |   | $                           | 133,879 |   | $ | 130,185 |   | $ | 164,352 |   | $ | 162,575 |   |

 

F-18

----

 

J.      Subsequent Event

 

On March 7, 2003,the Trust received a prepayment of the Oasis at Springtree Additional Loannote.  The Trust received $2,290,000 ofAdditional Loan principal and $2,365,276 of Shared Appreciation Interest.  The Trust will pay a special dividend of$.26 per share from the proceeds of the Oasis at Springtree Additional Loanprepayment during the first half of 2003.

 

F-19

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KRUPP GOVERNMENTINCOME TRUST II

 

SCHEDULE II – VALUATIONAND QUALIFYING ACCOUNTS

 
| 2002                |   |                                 |      |                                |   |          |   |                           |       |
|---------------------|--------|--------------------------------------|-----------|-------------------------------------|--------|---------------|--------|--------------------------------|------------|
|                |   |                                 |      |                                |   |          |   |                           |       |
| **Description**     |   | **Balance at  Beginning  of period** |      | **Charged to  costs and  expenses** |   | **Reversals** |   | **Balance at  end of  period** |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| Valuation Allowance |   | $                                    | 500,000   |                                | $      | —        |   | $                              | (500,000   | ) | $ | — |   |
|                |   |                                 |      |                                |   |          |   |                           |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| 2001                |   |                                 |      |                                |   |          |   |                           |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| **Description**     |   | **Balance at  Beginning  of period** |      | **Charged to  costs and  expenses** |   | **Reversals** |   | **Balance at  end of  period** |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| Valuation Allowance |   | $                                    | 2,000,000 |                                | $      | —        |   | $                              | (1,500,000 | ) | $ | 500,000 |   |
|                |   |                                 |      |                                |   |          |   |                           |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| 2000                |   |                                 |      |                                |   |          |   |                           |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| **Description**     |   | **Balance at  Beginning  of period** |      | **Charged to  costs and  expenses** |   | **Reversals** |   | **Balance at  end of  period** |       |
|                |   |                                 |      |                                |   |          |   |                           |       |
| Valuation Allowance |   | $                                    | 2,994,000 |                                | $      | —        |   | $                              | (994,000   | ) | $ | 2,000,000 |   |

 

F-20

----

 

KRUPP GOVERNMENTINCOME TRUST II

SUPPLEMENTARY DATA

SELECTED QUARTERLYFINANCIAL DATA

(Unaudited)

 

For the Quarter Ended

 
|               |   | **March 31,  2002** |      | **June 30,  2002** |   | **September  30,  2002** |   | **December  31,  2002** |      |
|--------------------|--------|---------------------|-----------|--------------------|--------|--------------------------|--------|-------------------------|-----------|
|               |   |                |      |               |   |                     |   |                    |      |
| Total revenues     |   | $                   | 7,126,266 |               | $      | 2,200,656                |   | $                       | 2,680,751 |   | $ | 5,350,966 |   |
|               |   |                |      |               |   |                     |   |                    |      |
| Net income         |   | $                   | 5,944,486 |               | $      | 1,530,728                |   | $                       | 1,959,918 |   | $ | 4,602,250 |   |
|               |   |                |      |               |   |                     |   |                    |      |
| Earnings per Share |   | $                   | .32       |               | $      | .09                      |   | $                       | .10       |   | $ | .25 |   |

 

For the Quarter Ended

 
|               |   | **March 31,  2001** |      | **June 30,  2001** | ** ** | **September 30,  2001** | ** ** | **December 31,  2001** |       |
|--------------------|--------|---------------------|-----------|--------------------|------------|-------------------------|------------|------------------------|------------|
|               |   |                |      |               |       |                    |       |                   |       |
| Total revenues     |   | $                   | 6,360,137 |               | $          | 3,476,744               |       | $                      | 12,808,257 |   | $ | 2,684,679 |   |
|               |   |                |      |               |       |                    |       |                   |       |
| Net income         |   | $                   | 4,926,015 |               | $          | 2,516,304               |       | $                      | 11,911,501 |   | $ | 2,787,158 |   |
|               |   |                |      |               |       |                    |       |                   |       |
| Earnings per Share |   | $                   | .27       |               | $          | .14                     |       | $                      | .64        |   | $ | .16 |   |

 

F-21

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