<PAGE>   1



                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-K

  X    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 ---   EXCHANGE ACT OF 1934 (NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996).

       For the fiscal year ended December 31, 1996
                                     OR
 ----  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934

       For the transition period from                     to
                                      -------------------    ----------------
       Commission file number    0-15693

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


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

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

Registrant's telephone number, including area code       (770) 671-1014
                                                  ---------------------------
        Formerly: Southmark/CRCA Health Care Fund VII, L.P.
-----------------------------------------------------------------------------

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

       Title of each class      Name of exchange on which registered
            None                            None
       -------------------      ------------------------------------

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

Limited Partnership Interests

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.     Yes  X     No
                                           ---       ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  [ X ]

All of the registrant's 279,278 limited partnership interests are held by
non-affiliates.  The aggregate market value of interests held by non-affiliates
is not determinable since there is no public trading market for the limited
partnership interests and transfers of the limited partnership interests are
subject to certain restrictions.

Documents Incorporated by Reference: See Page 32
Exhibit Index:  See Page 32-34

                               TOTAL OF 35 PAGES





                                       1
<PAGE>   2


                                     Part I

ITEM 1  BUSINESS

Quest Health Care Fund VII, L.P. (the Partnership), formerly Southmark/CRCA
Health Care Fund VII, L.P., was organized on July 23, 1986, as a limited
partnership under the provisions of the Delaware Revised Uniform Limited
Partnership Act.  On September 12, 1986, a Registration Statement on Form S-1
was declared effective by the Securities and Exchange Commission whereby the
Partnership offered for sale $30,000,000 of limited partnership interests (the
Units).  The Units represent equity interests in the Partnership and entitle
the holders thereof to participate in certain allocations and distributions of
the Partnership.  The offering of the Units closed in June 1987, with 279,278
Units sold at $100 each, or gross proceeds of $27,927,800 to the Partnership.

The General Partner of the Partnership is Quest Rescue Partners - 7, L.P.
(Quest) whose sole limited partner is Quest Financial Corp. and whose sole
general partner is Quest Rescue Partners - 7 Corp.  Quest became the General
Partner of the Partnership on August 1, 1990.

The former general partner of the Partnership was Southmark Investment Group
86, Inc. (SIG), a Nevada corporation and a wholly-owned subsidiary of Southmark
Corporation (Southmark).

The Partnership's primary business and only industry segment is to own, invest
in, operate and ultimately dispose of a diversified portfolio of health care
related real properties for the benefit of its Partners.  At December 31, 1996,
the Partnership held interests in three nursing home properties as described in
Item 2 below and the Partnership employed approximately 228 full and part time
persons, including administrative, nursing, dietary, laundry, housekeeping,
social services and maintenance personnel.

The services provided at the Partnership's long-term care facilities consist of
intermediate and skilled nursing care.  Intermediate care consists of providing
assistance or supervision with daily activities such as dressing, bathing, diet
or medication.  Skilled nursing care consists of 24 hour a day services of
registered nurses and related medical services prescribed by the resident's
physician.  Under the Omnibus Budget Reconciliation Act (OBRA), which became
effective October 1, 1990, the distinction between skilled nursing and
intermediate care facilities was eliminated.  The legislation imposed a variety
of new quality of care requirements on all long-term care facilities, with
resulting increases in operating costs.  The legislation imposed more stringent
requirements regarding staff, screening and assessment of residents, resident
rights, and survey and certification requirements.  It also subjects facilities
to a number of sanctions, including civil money penalties, for substandard
survey results.  Under this  legislation, states are required to amend their
Medicaid plans to make an appropriate adjustment in the rates at which they
reimburse long- term care facilities in order to reflect the costs of these new
requirements.  There is, however, no requirement that the rate adjustments
actually cover all new costs nor are there any assurances that state budgetary
constraints will sustain the costs associated with federal mandates.





                                       2
<PAGE>   3

During 1995, the final regulations pertaining to OBRA 87 were instituted.  OBRA
87 contained, among other things, new stringent survey requirements with severe
penalties for non-compliance.  In 1996, the expenses of the facilities have
increased as a result of increased personnel costs necessary to comply with
OBRA 87.  The Partnership's facilities that provide skilled care are certified
to receive benefits under the Federal Health Insurance for the Aged Act
(Medicare) and under joint federal and state funded programs administered by
the various states to provide medical assistance to the indigent, known
generally as Medicaid.  Benefits under Medicare are for skilled care only.
However, Medicaid plans provide for different levels of reimbursement,
depending upon the level of care and services rendered.

Medicaid reimbursement formulas are established in accordance with Federal
guidelines, by each state, with the approval of the Federal government and vary
from state to state.  Typically, Medicaid formulas provide for reimbursement
for specified services up to specified limits based on historical costs, with
adjustments for inflation.  Federal law requires that Medicaid reimbursement
rates be reasonable and adequate to meet the cost which must be incurred by
efficiently and economically operated facilities in order to provide care and
services in conformity with applicable laws, regulations and quality and safety
standards.  Medicaid payments are set either retrospectively, prospectively, on
a flat rate basis or a combination thereof.  The Medicare and Medicaid programs
are subject to statutory and regulatory changes, administrative rulings,
political fiats, interpretations of policy and determinations by
intermediaries, and to governmental funding restrictions, all of which may
materially increase or decrease the rate of program payments to long-term care
facilities, such as those owned by the Partnership.

In the operation of health care facilities, the Partnership competes with a
number of individuals and entities, including large, national nursing home
chains and small, locally owned nursing care facilities.  Some competing
operators have greater financial resources than the Partnership or may operate
on a nonprofit basis or as charitable organizations.  The degree of success
with which the Partnership's facilities compete varies from location to
location and depends on a number of factors.  There is limited, if any,
competition in price with respect to Medicaid and Medicare patients, since
revenue for services to such patients is strictly controlled and based on fixed
rates and cost reimbursement principles.

In light of these factors, the Partnership will continue to seek to meet
competition in each locality by improving the appearances and the quality of
services provided at its facilities, establishing a reputation within the local
medical communities for providing competent care services, and by responding
appropriately to regional variations in demographics and tastes.

During 1995, the Partnership's interest in five of the Partnership's facilities
were sold. Please refer to Part II, Item 7 for further discussion.





                                       3
<PAGE>   4

The following table sets forth information regarding the average daily census
and sources of patient revenues at the Partnership's facilities:


<TABLE>
<CAPTION>
                             Average Daily Census             Revenues for
                                for Year Ended                Year Ended
                                   December 31,               December 31,

                         ----------------------------    ----------------------
                           1994       1995       1996     1994    1995    1996
                         --------   --------  ---------   -----   -----   ----
<S>                      <C>  <C>   <C> <C>   <C> <C>     <C>     <C>     <C>
Medicaid                 551   77%  112  53%  105  52%     65%     58%     49%
Private Pay              112   16%   32  15%   28  14%     14%     13%     12%
VA, Medicare and Other    50    7%   68  32%   68  34%     21%     29%     39%
                         ---  ---   --- ---   --- ---     ---     ---     ---

                         713  100%  212 100%  201 100%    100%     100%   100%
                        ==== ====   === ===   === ===     ===      ===    ===

Overall Occupancy Rate         85%       84%       81%
                              ===       ===       ===
</TABLE>


Because of a changing census mix, the occupancy required for a facility to
achieve an operating break-even point cannot be determined precisely.
Generally, a greater ratio of Medicaid patients will require a higher occupancy
to reach a break-even point.  However, a high Medicare census changes the
break-even point due to a higher reimbursement rate even though expenses
associated with Medicare qualified residents are significantly higher than
Medicaid.

All licensed beds in the Partnership's facilities are being utilized, except
that in some  instances, semi-private rooms have been converted to private
rooms to accommodate demand or a small number of rooms have been taken out of
service to be utilized for office space and ancillary support areas.


ITEM 2  PROPERTIES


The following table sets forth the investment portfolio of the Partnership at
December 31, 1996.  The buildings and the land on which they are located are
owned by the Partnership through its majority-owned partnerships in fee.

The Partnership's majority-owned partnerships were a creation of Southmark to
enable the Partnership to acquire properties from Southmark affiliates without
paying transfer taxes or having to perform relicensing of the homes more than
once.  The Southmark affiliate had already paid the tax and relicensed the
facility prior to the acquisition by the Partnership.  There appears to have
been no adverse economic impact on the Partnership by this arrangement.  Quest
maintained the arrangement to avoid creating tax and relicensing problems
associated with dissolving the majority owned partnerships.  Quest has not
received any financial benefit from this ownership structure.





                                       4
<PAGE>   5


ITEM 2  PROPERTIES continued
<TABLE>
<CAPTION>
                                                                   Properties       Occupancy
                                                                      at net          Rate            Date
Property                          Description                      book value       for 1996        Acquired
--------                          -----------                      ----------       ---------       --------
<S>                               <C>                              <C>               <C>          <C>
Mountain View                     Skilled Care
Care Center                       Nursing Home
Kimberly, ID                      64 Licensed Beds                   $102,556         48%         June 1987

Valley Living Center              Personal Care
Idaho Falls, ID                   Nursing Home
                                  65 Licensed Beds                   $198,846         93%         June 1987
Valley Convalescent               Skilled/Personal
Hospital                          Care Nursing Home
El Centro, CA                     123 Licensed Beds                  $745,036         91%         June 1987

                                                                   $1,046,437
----------------------------------------                            =========
TOTAL: 3  Nursing Homes               249 Licensed Beds
</TABLE>

ITEM 3  LEGAL PROCEEDINGS

The State of Idaho sought a deficiency lien against the Partnership's Idaho
facilities for sales and use taxes for periods prior to ownership by the
Partnership.  The total amount claimed by the state is $372,921.  Management of
the Partnership is discussing a settlement of this matter with the state and
has recorded its best estimate of this liability by recording a provision of
$279,691 in the Partnership's Financial Statements in 1994.  Management is of
the opinion that the maximum exposure to the Partnership, in excess of accrued
amounts, is $93,230 plus additional penalties and interest, if any.  The
Partnership plans to continue to vigorously defend itself against these claims.
As of year end 1996, the state was reassessing their position relative to the
claims. Upon settlement, the difference between the settlement amount and the
$279,691 will be reflected in results from operations.

In 1994, a complaint associated with a sexual harassment and wrongful
termination was filed against the Partnership. The Partnership's liability, if
any, is not determinable at this time and no provision has been made in the
accompanying Financial Statements.  It is the opinion of management that the
ultimate resolution will not have a material effect on the Partnership's
financial position. There has been no significant change in the status of this
litigation since 1995.

In the fourth quarter of 1996, a complaint for discrimination and wrongful
termination was received by one of the Partnership's facilities.  Other than
the cost of defense, the complaint is not expected to have a material impact on
the Partnership as management believes the complaint is without merit.

ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None during the fourth quarter of 1996.





                                       5
<PAGE>   6


                                    Part II

ITEM 5  MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNERSHIP AND RELATED
SECURITY HOLDER MATTERS

(A)  No established public trading market for the Units exists nor is one
     expected to develop.

(B)  Title of Class                        Number of Record Unit Holders
     --------------                        -----------------------------
     Limited Partnership Interests         3,768 as of February 28, 1997

(C)  No cash distributions were made to the Limited Partners in 1990, 1991,
     1993, 1994 or 1996.  The Limited Partners received cash distributions of
     $488,736, $139,639 and $5,306,282 for the years ended December 31, 1989,
     1992 and 1995, respectively.  Cumulative distributions to the Limited
     Partners from the Partnership from its inception to December 31, 1996 were
     $8,567,428.  No distributions have been made to either SIG or Quest.  See
     the Liquidity and Capital Resources section of Item 7 - Management's
     Discussion and Analysis of Financial Condition and Results of Operations.

ITEM 6  SELECTED FINANCIAL DATA

The following table sets forth a summary of certain financial data for the
Partnership.  The settlement of litigation, the foreclosure of one property and
the write down of other properties significantly impacted the 1993 and 1994
financial information.  The gain on the sale of five properties in 1995
resulted in the significant improvement in net income.  This summary should be
read in conjunction with the Partnership's financial statements and the related
notes appearing in Item 8.


<TABLE>
<CAPTION>
                                                               Years ended December 31,
                                     -------------------------------------------------------------------------------
Statements of Operations                1996             1995             1994             1993             1992
------------------------             ----------       -----------      -----------      -----------      -----------
<S>                                  <C>           <C>           <C>                    <C>              <C>
Operating revenue                    $ 6,583,228      $11,951,586      $23,341,171      $24,067,958      $22,315,509
Net income (loss)                       (618,694)         533,537       (7,146,189)          95,883       (1,199,519)
Net income (loss) per                                          (1)              (2)              (3)
  weighted average Unit                    (2.19)            1.89           (25.33)             .34            (4.25)
Distributions paid per                                         (1)              (2)              (3)
  weighted average Unit                      -0-            19.00              -0-              -0-              .50
</TABLE>

(1)      Includes gain on sale of five facilities of $548,389 or $1.94 per
         unit.

(2)      Includes extraordinary gain of $64,012 or $.23 per unit from
         settlement of Healthcare Services Group payables and loss from
         writedown of properties of $7,180,571 or $(25.45) per unit.

(3)      Includes loss from write down of properties of $3,352,459 or $(11.88)
         per unit, loss from transfer of property of $1,510,559 or $(5.35) per
         unit, and extraordinary  gain of $4,869,365 or $17.26 per unit from
         extinguishment of debt and settlement of Southmark payables.





                                       6
<PAGE>   7



<TABLE>
<CAPTION>
                                                                   As of December 31,
                                     ------------------------------------------------------------------------------
Balance Sheets                           1996             1995             1994             1993             1992
--------------                       -----------      -----------      -----------      -----------      -----------
<S>                                  <C>              <C>              <C>              <C>           <C>
Property & Equipment,net             $ 1,046,437      $ 1,072,251      $ 6,980,953      $14,397,029      $18,113,000
Assets in receivership                         -                -                -                -        3,404,875
Total Assets                           2,922,708        3,480,604       12,238,692       18,887,317       25,464,388
Long-term obligations,
  less current maturities                      -            9,629        1,843,803        1,946,293        1,938,586
Long-term debt related to
  assets in receivership                       -                -                -                -        3,634,009
Partners' equity                       1,869,575        2,488,269        7,261,014       14,407,203       14,311,320
</TABLE>


ITEM 7    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

General

Certain statements in this Annual Report that are not historical fact
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.  Discussions containing
forward-looking statements may be found in this section and in the section
entitled "Business."  Without limiting the foregoing, words such as
"anticipates," "expects," "intends," "plans" and similar expressions are
intended to identify forward-looking statements.  These statements are subject
to a number of risks and uncertainties.  Actual results could differ materially
from those projected in the forward-looking statements.  The Partnership
undertakes no obligation to update these forward-looking statements to reflect
future events or circumstances.

RESULTS OF OPERATIONS

During 1996, the Partnership continued its efforts to sell the remaining
Partnership facilities.  During the fourth quarter, the Partnership reached an
agreement in principal to sell the Valley Convalescent facility.  Negotiations
continue to sell the other two facilities.

In February 1995, the Partnership sold its interest in one facility for a gain
of $200,446.  The Partnership was relieved of mortgage obligations secured by
the facility exceeding $1,830,000, and received cash of $1,700,000.  As a
result of the sale of the facility and cash on hand; the Partnership
distributed $2,792,780 or $10/unit to the limited partners in March 1995.

On April 30, 1995, the Partnership sold its interests in four of its facilities
to another unaffiliated third party.  The Partnership reflected an estimated
loss on the sale of these facilities of $4,898,869 at December 31, 1994 and
recognized a gain of $347,943 upon closing of the sale on April 30, 1995.  A
distribution from this sale of $2,513,502 or $9/unit was made to the limited
partners in June 1995.

Neither the General Partner nor its affiliates received any remuneration nor
distributions from the sale of facilities.





                                       7
<PAGE>   8

Revenues:

Operating revenues for the twelve month period ended December 31, 1996
decreased $5,368,358 when compared to the prior period.  This is primarily the
result of the sale of the Partnership's interests in five facilities.  On a
proforma basis, removing the effect of the sales, revenues decreased $65,676 in
1996 as compared to the same period in 1995.  This is partially the result of
$125,000 in prior year cost report adjustments in excess of recorded estimated
settlements for all facilities during the third quarter applied in 1996,
reflecting amounts due to Medicare for prior years, as well as the future
expected changes in Medicare allowable reimbursement levels.  In addition,
during the third quarter, the Valley Convalescent facility experienced lower
occupancies as a result of a bed hold precipitated by a unfavorable state
survey.  During the fourth quarter, the facility was cleared of all deficiency
claims of the state and occupancy is returning to the levels experienced prior
to the survey.

Operating revenues for the twelve month period ended December 31, 1995
decreased $11,389,585 when compared to the prior period.  This is primarily the
result of the sale of the Partnership's interests in five facilities. On a
proforma basis, removing the effect of the sales, revenues increased $514,997
in 1995 as compared to the same period in 1994.  The primary source of the
increase was from occupancy and rate increases at Valley Living Center and
Valley Convalescent Center, as well as increased Medicare utilization. Revenue
in 1995 included $5,300,332 related to the five sold facilities.

Receivables from Medicaid/Medicare eligible residents do not present a
significant credit risk as the Medicaid/Medicare system is federally financed.
Receivables are, however, subject to disallowance by Medicare and Medicaid upon
audit.  Such governmental audits are typically one or two years in arrears.
Inflation is not a material factor due to the fact that reimbursement rates are
set by governmental agencies, however, such agencies are not obliged to
increase the reimbursement rate at the rate of inflation.

The significant components of accounts receivable at December 31, 1996 and 1995
were:
<TABLE>
<CAPTION>
                                1996       1995
                               ------     ------
    <S>                          <C>        <C>
    Medicaid                      47%        47%
    Private Pay                    9%        10%
    VA, Medicare & Other          44%        43%
                               ------     ------
                                 100%       100%
                               ======     ======
</TABLE>

Payments by both the state and federal governments are normally received within
60-90 days.  The receivables of the Partnership represent less than 48 days
revenue.

Expenses:

For the twelve month period ending December 31, 1996, total expenses decreased
$4,788,830 compared to the prior period.  On a pro forma basis, eliminating the
effect of the five sold facility interests, operating expenses increased
$556,057.  Two thirds of this increase relates to additional personnel
necessary to comply with OBRA 87 and wage increases needed to compete for
employees with





                                       8
<PAGE>   9

non-health care related employers.  The remainder is primarily legal expense
incurred defending the Partnership against former employee legal claims.

For the twelve month period ending December 31, 1995, total expenses decreased
$18,578,430 compared to the prior period.  On a pro forma basis, eliminating
the effect of the five sold facility interests and the writedowns that occurred
in 1994, operating expenses decreased $53,461.  This is primarily related to
increased labor costs associated with complying with the final regulations
issued in 1995 relating to OBRA 87 and wage inflation offset by aggressive
expense control and staff reductions at Mountain View in line with its reduced
occupancy.  Supplies and Ancillary expense increased $316,320 at Valley
Convalescent as a result of increased occupancy and Medicare utilization.
Total expenses in 1995 included $5,156,944 relating to the five sold facility
interests.

Consistent with the Partnership's accounting policy as described in Note A, the
Partnership reflected property and equipment as of December 31, 1994 at the
lower of cost (as previously adjusted for writedowns, if applicable) or
estimated net realizable value, determined on an individual nursing home basis.
Loss from writedowns of properties in 1994 were $7,180,571 which included
writedowns of $762,797 and $1,518,905 related to Valley Living Center and
Valley Convalescent Center, respectively. (Note F).

As of December 31, 1996, management estimates that fair value exceeds the
carrying value and, accordingly, does not expect any further material
adjustments under Statement of Accounting Standard No. 121 unless warranted by
future changes in market conditions or other relevant factors.

Based on the carrying value of the Partnership's interests in the four
facilities sold in May 1995, the Partnership expected to incur a loss on the
sale and, accordingly, recognized this loss at December 31, 1994 in the
accompanying statements of operations of $4,898,869 consisting of a writedown
of property and equipment of $4,466,946 for the Partnership's interests
contracted to be sold and $431,923 for the 25% discount of accounts receivable.

Ancillary Revenue and Expense is a term that describes specialized services
provided by third party unaffiliated vendors.  These services include speech,
occupational, physical and occasionally intravenous therapies.  These revenues
and expenses are subject to certain cost limitations and do not materially
effect the profitability of a facility.  However, the ability to provide these
services enables a facility to accept residents reimbursed under the federal
Medicare system.  Typically, the Medicare system reimburses at a higher daily
rate than Medicaid.  These Medicare residents are people, not necessarily
elderly, who, under another set of regulations, must be discharged from
hospitals before they are well enough to go home.  The result is that nursing
homes that once were a final stop in life's journey have become more like
auxiliary hospitals with a substantially shortened length of stay.  The pursuit
of high reimbursement Medicare residents limits the number of Medicaid beds
available to the indigent elderly.  These people will be required to live with
relatives or find low skilled "foster care" or community based services.
Additional challenges confronting the Partnership are market competition and
state budgetary restraints.





                                       9
<PAGE>   10

The Valley Convalescent facility, located in the desert town of El Centro,
California, has continued to experience increased personnel costs associated
with attracting qualified personnel from a competency challenged labor pool.
Despite a small Medicaid rate increase, after a three year freeze, the facility
is highly dependent on Medicare for its profitability.  Whatever action
Congress may take to reduce Medicare payments will have a significant, but, as
yet, un quantifiable impact on the facility.

Valley Living, in Idaho Falls, Idaho, has experienced a nearly 20% decrease in
occupancy as the result of the opening of a new, competing facility in town.
While the facility remains profitable, it is doubtful revenues will be
sustainable at prior year levels.

Mountain View Care Center, located in Kimberly, Idaho, has not been able to
successfully challenge the competition that opened in 1993, due to its age and
location.  To protect the interests of the Partnership, the Mountain View
facility must continue operations pending a resolution of the sales tax claims
and the employee complaint.  (See Item 8, Note E)


Liquidity and Capital Resources

At December 31, 1996, the Partnership held cash and cash equivalents of
$896,687, a decrease of $428,634 over 1995.

At December 31, 1995, the Partnership held cash and cash equivalents of
$1,325,321, a decrease of $144,138 over 1994.  The decrease is due to the
distributions to limited partners which exceeded the cash provided by the sales
and the positive cash flow from operations.

In February 1995, the Partnership sold its interest in one facility for a gain
of $200,446.  The Partnership was relieved of mortgage obligations secured by
the facility exceeding $1,830,000, and received cash of $1,700,000.  As a
result of the sale of the facility and cash on hand; the Partnership
distributed $2,792,780 or $10/unit to the limited partners in March 1995.

At April 30, 1995 the Partnership sold its interests in four of its facilities
to another unaffiliated third party resulting in a gain of $347,943.  A
distribution from this sale of $2,513,502 or $9/unit was made to the limited
partners in June 1995.

Neither the General Partner nor its affiliates received any remuneration or
distributions from the sale of facilities.

During the fourth quarter of 1994 the State of Idaho asserted a $470,135
deficiency lien against the Partnership's Idaho properties for periods from
1976 through 1988, under a theory of successor liability.  Of this amount,
$372,921 relates to the remaining two facilities owned as of December 31, 1996,
located in Idaho.  The Partnership acquired its interests in these properties
in June 1987.  Although the Partnership believes it has a number of meritorious
defenses to the claims of the State of Idaho, an expense was accrued in the
fourth quarter of 1994 in the amount of $352,602.  The liability reflected as
of December 31, 1996 is $279,691 for the remaining two facilities.  Any
settlement with the state





                                       10
<PAGE>   11

for an amount different than this accrual will be reflected in the results from
operations. As of year end 1996, the State of Idaho was reassessing their legal
position relative to their claims.

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

The Partnership's Balance Sheet, at December 31, 1994, reflected the lower of
costs or estimated net realizable value, at that date, of property and
equipment. The significant writedown of property and equipment in 1994 was
based on the Partnership's future plans for its interests in the nursing
facilities and the attendant accounting policies.  At December 31, 1993, the
nursing facilities were considered operating assets since it was the
Partnership's plan to continue to operate the facilities as it had in the past.
Consistent with generally accepted accounting principals ("GAAP") and the
Partnership's accounting policy for operating assets, property and equipment
were carried in the 1993 balance sheet at the lower of cost or estimated
undiscounted future cash flows expected to be generated over the remaining
estimated useful life of the property and equipment. The remaining estimated
useful life of the property and equipment at December 31, 1993 was
approximately 23 years.

It is not the objective of GAAP to reflect operating property and equipment at
estimated market value less costs of disposal, otherwise known as estimated net
realizable value. Instead, under GAAP most property and equipment is carried at
cost less accumulated depreciation taken over the years of prior service.

During 1994, as described in the notes to the Financial Statements, the
Partnership determined that it would market for sale its interests in the
nursing facilities. Since the future life under these circumstances is the
length of time required to dispose of the assets as opposed to the much longer
term of the assets remaining useful operating life, GAAP and the Partnership's
accounting policy require that the property and equipment under these
circumstances be carried at the lower of cost (the then existing carrying
value) or estimated net realizable value. Accordingly, under these
circumstances, the time value of money (over approximately 22 remaining years),
the risk of capital invested, local, national and industry conditions including
competition, state and federal reimbursement plans and patient mix, among many
other factors, are taken into consideration. Consequently, as a result of a
change in the Partnership's future direction, a loss on property and equipment
representing the difference in (1) the carrying value as determined based on
the lower of cost or estimated undiscounted future cash flows over the
remaining estimated useful life for operating assets, and (2) the lower of cost
or estimated net realizable value at that time was recognized during 1994 in
the amount of $6,748,648 and is  reflected in the 1994 Financial Statements.





                                       11
<PAGE>   12


Effective October 1, 1990, federal legislation, OBRA, eliminated the
distinction between skilled nursing and intermediate care facilities and
imposed a variety of quality of care requirements on all long-term care
facilities, with resulting increases in operating costs.  The legislation also
imposes more stringent requirements regarding staff, screening and assessment
of residents, resident rights and survey and certification requirements.  Under
this legislation, states are required to amend their Medicaid plans to make an
appropriate adjustment in the rates at which they reimburse long-term care
facilities in order to reflect the costs of these new requirements.  There is,
however, no requirement that the rate adjustments actually cover all costs nor
are there any assurances that state budgetary constraints will sustain the cost
of future federal mandates.

Medicare is a federal entitlement program and Medicaid (the source of the
majority of the Partnership's revenues) represents an entitlement program
administered differently by each state which is partially funded by the Federal
government.  In August 1993, Congress enacted Title XIII of OBRA 93.  This act,
among other things taxed social security benefits received by the elderly and
further limited payments under state Medicaid programs for which federal
matching would be permitted.  In October 1993, the Health Care Financial
Administration (HCFA) implemented a freeze on Medicare reimbursement, on
routine cost limits, certain Part B ancillaries and prospective payment system
rates.  In addition, HCFA eliminated the return on equity component of the
reimbursement rate.   Further, by the end of 1993, several states; because of
federal actions and/or budgetary difficulties, had either taken action to
curtail the growth in entitlement programs and/or had indicated that future
action was possible. Despite the fact that health care reform proposals at the
federal level are dead, activities at the state level continue and are
encouraged by HCFA.  In 1996, the latest idea continues to be "block grants" to
the states and significant Medicare budgetary reductions.  What this means to
nursing facilities cannot currently be determined by management of the
Partnership.

Private pay sources accounted for 12% of the Partnership's total revenue in
1996, all other revenue came from federal and state entitlement programs.  Any
reduction in these programs will have an immediate impact on the total revenue
and cash flow of the Partnership.

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





                                       12
<PAGE>   13






ITEM 8   FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

                        QUEST HEALTH CARE FUND VII, L.P.
                         INDEX TO FINANCIAL STATEMENTS


<TABLE>
<CAPTION>


                                                                       Page
                                                                       ----
<S>                                                                    <C>
REPORT OF INDEPENDENT ACCOUNTANTS                                      14

BALANCE SHEETS
     as of December 31, 1996 and 1995                                  15-16

STATEMENTS OF OPERATIONS
     for the years ended December 31, 1996, 1995 and 1994              17

STATEMENTS OF PARTNERS' EQUITY
     for the years ended December 31, 1996, 1995 and 1994              18

STATEMENTS OF CASH FLOWS
     for the years ended December 31, 1996, 1995 and 1994              19-20

NOTES TO FINANCIAL STATEMENTS                                          21

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
     for the years ended December 31, 1996, 1995 and 1994              30
</TABLE>


All other schedules are omitted since they are not required, are not applicable
or the financial information required is included in the financial statements
or the notes thereto.





                                       13
<PAGE>   14


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Partners
Quest Health Care
  Fund VII, L.P.


We have audited the financial statements and financial statement schedule of
Quest Health Care Fund VII, L.P. listed in the index of this Form 10-K.  These
financial statements and financial statement schedule are the responsibility of
the Partnership's management.  Our responsibility is to express an opinion on
these financial statements and financial statement schedule based on our
audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Quest Health Care Fund VII,
L.P. as of December 31, 1996 and 1995, and the results of its operations and
its cash flows for the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.  In addition, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, present fairly, in
all material respects, the information required to be included therein.

As discussed in Note F to the accompanying financial statements, the
Partnership decided to market for sale its operating property and equipment
during 1994.  Prior to that decision, in accordance with generally accepted
accounting principles, the Partnership carried operating property and equipment
in its consolidated financial statements at the lower of cost or estimated
undiscounted future cash flows, before interest charges, on an individual
property basis.  As a result of this decision, the Partnership has written down
its property and equipment to an estimated net realizable value as determined
by management through a charge to earnings of $7,180,571 in 1994.  As discussed
in Note I, the Partnership is currently marketing for sale its operating assets
and intends to liquidate the Partnership thereafter.

Coopers & Lybrand LLP

Raleigh, North Carolina
March 27, 1997





                                       14
<PAGE>   15

                        QUEST HEALTH CARE FUND VII, L.P.
                                 BALANCE SHEETS
                           December 31, 1996 and 1995





<TABLE>
<CAPTION>

ASSETS                                                    1996          1995
------                                                 -----------   -----------
<S>                                                    <C>          <C>
CURRENT ASSETS:
  Cash and cash equivalents                            $   896,687  $  1,325,321
  Accounts receivable, net of allowance for
    doubtful accounts of $33,495 and $25,000 in
    1996 and 1995, respectively                            850,173       914,057
  Prepaid expenses                                         129,411       168,975
                                                        ----------    ----------
   Total current assets                                  1,876,271     2,408,353
                                                        ----------    ----------

PROPERTY AND EQUIPMENT,
  Land                                                     234,662       233,770
  Buildings and improvements                             2,388,741     2,380,901
  Equipment and furnishings                                797,346       755,289
                                                        ----------    ----------
                                                         3,420,749     3,369,960
  Less accumulated depreciation and amortization         2,374,312     2,297,709
                                                        ----------    ----------
    Net property and equipment                           1,046,437     1,072,251
                                                        ----------    ----------


          TOTAL ASSETS                                 $ 2,922,708   $ 3,480,604
                                                        ==========    ==========
</TABLE>





See notes to financial statements.





                                       15
<PAGE>   16


                       QUEST HEALTH CARE FUND VII, L.P.
                          BALANCE SHEETS - CONTINUED
                          December 31, 1996 and 1995





<TABLE>
<CAPTION>
                                                          1996         1995
                                                      -----------  ------------
<S>                                                    <C>           <C>
LIABILITIES AND PARTNERS' EQUITY
--------------------------------

CURRENT LIABILITIES:
  Current maturities of long-term obligations          $     9,629   $    14,754
  Trade accounts payable                                   286,815       334,994
  Accrued compensation                                     121,404       116,582
  Accrued insurance                                         92,885       103,962
  Estimated third party settlements                        177,779        26,695
  Estimated sales tax settlement                           279,691       279,691
  Other                                                     81,045        94,036
  Payable to Quest and affiliates                            3,885        11,992
                                                        ----------    ----------
    Total current liabilities                            1,053,133       982,706


LONG-TERM OBLIGATIONS, less current maturities                   -         9,629
                                                        ----------    ----------
    Total liabilities                                    1,053,133       992,335
                                                        ----------    ----------


PARTNERS' EQUITY (DEFICIT):
  Limited Partners                                       2,013,168     2,625,675
  General Partner                                         (143,593)     (137,406)
                                                        ----------    ----------
    Total partners' equity                               1,869,575     2,488,269
                                                        ----------    ----------

    TOTAL LIABILITIES AND PARTNERS' EQUITY             $ 2,922,708   $ 3,480,604
                                                        ==========    ==========
</TABLE>




See notes to financial statements.





                                       16
<PAGE>   17

                        QUEST HEALTH CARE FUND VII, L.P.
                            STATEMENTS OF OPERATIONS
              For the Years Ended December 31, 1996, 1995 and 1994

<TABLE>
<CAPTION>
                                              1996         1995         1994
                                          -----------  -----------  -----------
<S>                                       <C>          <C>          <C>
REVENUES:
  Operating revenue                       $ 6,583,228  $11,951,586  $23,341,171
  Interest income                              36,488       60,802       54,298
  Gain on sales                                     -      548,389            -
                                           ----------   ----------   ----------
    Total revenues                          6,619,716   12,560,777   23,395,469
                                           ----------   ----------   ----------

EXPENSES:
  Wages and salaries                        3,166,852    5,517,823   10,648,385
  Payroll tax & employee benefits             562,490    1,025,189    2,093,889
  Supplies                                    874,445    1,266,143    2,233,580
  Other operating costs                       703,769    1,207,134    3,154,364
  Ancillary services                          869,333    1,216,170    1,887,981
  Health benefits                             135,120      198,210      249,065
  Management fees                             331,027      618,306    1,280,662
  Management fees-affiliate                    67,057      113,966      191,258
  Property taxes                               61,651       82,333      163,305
  Interest                                      2,339       28,179      193,055
  Depreciation & amortization                  76,603      174,379      698,568
  Partnership administration                  387,724      579,408      630,987
  Loss from write down of
      properties                                    -            -    7,180,571
                                           ----------  -----------   ----------
      Total expenses                        7,238,410   12,027,240   30,605,670
                                           ----------  -----------   ----------

Net income (loss) before
  extraordinary gain                      $  (618,694) $   533,537  $(7,210,201)

 Extraordinary items
  Gain from settlement-HSG
    payables                                        -             -      64,012
                                           ----------    ----------  ----------

Net income (loss)                         $  (618,694)  $   533,537 $(7,146,189)
                                           ==========    ==========  ==========

Net income (loss) per limited
  partnership unit

  Income (loss) before
    extraordinary gain                    $     (2.19)         1.89      (25.56)
  Extraordinary items                               -             -         .23
                                           ----------    ----------  ----------

Net income (loss) per limited
  partnership unit                        $     (2.19)  $      1.89  $   (25.33)
                                           ==========    ==========   =========

Distributions paid per limited
  partnership unit                        $         -   $     19.00  $        -
                                           ==========    ==========   =========

Weighted average limited partnership
  units outstanding                           279,278       279,278     279,278
                                           ==========    ==========    ========
</TABLE>

See notes to financial statements.





                                       17
<PAGE>   18


                        QUEST HEALTH CARE FUND VII, L.P.
                         STATEMENTS OF PARTNERS' EQUITY
              For the Years Ended December 31, 1996, 1995 and 1994




<TABLE>
<CAPTION>
                                                                       Total
                                              General     Limited     Partners'
                                              Partner     Partners     Equity
                                             --------    ----------   ---------
<S>                                          <C>        <C>           <C>
Balance at December 31, 1994                  (142,741)   7,403,755     7,261,014

Net income                                       5,335      528,202       533,537

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

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

Net income (loss)                               (6,187)    (612,507)     (618,694)
                                              --------   ----------     ---------

Balance at December 31, 1996                 $(143,593) $ 2,013,168   $ 1,869,575
                                              ========   ==========    ==========
</TABLE>





See notes to financial statements.





                                       18
<PAGE>   19


                        QUEST HEALTH CARE FUND VII, L.P.
                            STATEMENTS OF CASH FLOWS
              For the Years Ended December 31, 1996, 1995 and 1994





<TABLE>
<CAPTION>
                                             1996        1995         1994
                                         -----------  -----------  -----------
<S>                                     <C>          <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Cash received from residents and
    government agencies                 $ 6,647,112  $12,361,404  $23,042,388
  Cash paid to suppliers and employees   (6,959,602) (12,117,721) (22,326,602)
  Interest received                          36,488       60,802       54,298
  Interest paid                              (2,339)     (28,179)    (193,860)
  Real estate taxes paid                    (84,750)    (119,120)    (148,473)
                                         ----------   ----------   ----------
  Net cash provided by (used in)
    operating activities                   (363,091)     157,186      427,751
                                         ----------   ----------   ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Payment for purchases of property
    and equipment                           (50,789)     (39,434)     (68,819)
  Proceeds from sale of property                  -    5,070,998       40,326
  Reduction of restricted escrow and other        -            -       71,486
  Funding of restricted accounts                  -       (4,495)      (7,262)
                                         ----------   ----------   ----------
  Net cash provided by (used in)
    investing activities                    (50,789)   5,027,069       35,731
                                         ----------   ----------   ----------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Bond refinancing costs                          -            -      (55,409)
  Bond or loan proceeds                           -            -    1,830,000
  Bond paid off                                   -            -   (1,830,000)
  Principal payments on debt
    obligations                             (14,754)     (22,111)     (96,525)
  Distributions to Partners                       -   (5,306,282)           -
                                         ----------   ----------   ----------
  Net cash used in
    financing activities                    (14,754)  (5,328,393)    (151,934)
                                         ----------   ----------   ----------

INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS                              (428,634)    (144,138)     311,548
  Cash and cash equivalents at the
    beginning of the year                 1,325,321    1,469,459    1,157,911
                                         ----------   -----------   ---------
  Cash and cash equivalents at the
    end of the year                     $   896,687  $ 1,325,321   $1,469,459
                                         ==========   ===========   =========
</TABLE>





See notes to financial statements.





                                       19
<PAGE>   20


                        QUEST HEALTH CARE FUND VII, L.P.
                            STATEMENTS OF CASH FLOWS
              For the Years Ended December 31, 1996, 1995 and 1994



<TABLE>
<CAPTION>
                                             1996        1995         1994
                                         -----------  -----------  -----------
<S>                                     <C>          <C>         <C>
RECONCILIATION OF NET INCOME (LOSS)
  TO NET CASH PROVIDED BY (USED IN)
  OPERATING ACTIVITIES

Net income (loss)                       $  (618,694) $   533,537  $(7,146,189)
Adjustments to reconcile net income
  (loss) to net cash provided by
  operating activities:
    Depreciation and amortization            76,603      174,379      698,568
    Gain on sale of facilities                    -     (548,389)           -
    Charge off of abandoned development
      costs or deferred loan costs                -       92,303            -
    Loss from write down of properties            -            -    7,180,571
    Loss on transfer of property                  -            -        2,174
    Settlement HSG payables                       -            -      (64,012)
  Changes net of effect of sold or
    foreclosed facilities:
        Accounts receivable                  63,884      409,818     (300,957)
        Prepaid expenses and
          other current assets               39,564     (186,104)    (598,147)
        Accounts payable and accrued
          liabilities                        83,659     (301,174)     643,791
        Payable to Quest                     (8,107)     (17,184)      11,952
                                         ----------   ----------   ----------

Net cash provided by (used in)
  operating activities                  $  (363,091) $   157,186  $   427,751
                                         ==========   ==========   ==========

</TABLE>




SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:


<TABLE>
<CAPTION>
                                            1996           1995        1994
                                         ----------     ----------  ----------
<S>                                      <C>          <C>            <C>
Debt assumed by purchaser in sale        $       -    $   63,300     $      -
</TABLE>





See notes to financial statements.





                                       20
<PAGE>   21


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.Organization

Quest Health Care Fund VII, L.P. (the Partnership) formerly Southmark/CRCA
Health Care Fund VII, L.P., was organized on July 23, 1986, as a limited
partnership under the provisions of the Delaware Revised Uniform Limited
Partnership Act, to acquire and operate income-producing health care related
properties.

On August 1, 1990, Quest Rescue Partners - 7, L.P. (Quest) became the general
partner of the Partnership.  Quest's sole general partner is Quest Rescue
Partners - 7 Corp. and its sole limited partner is Quest Financial Corp.

Southmark Investment Group 86, Inc. (SIG), a Nevada corporation and a
wholly-owned subsidiary of Southmark Corporation (Southmark), was the general
partner of the Partnership prior to August 1, 1990.

The Partnership's primary business and only industry segment is to own, invest
in, operate and ultimately dispose of health care related facilities for the
benefit of its partners.  The services provided at the Partnership's long-term
care facilities, which are primarily located in the western United States,
consist of intermediate and skilled nursing care.

The financial statements include the accounts of the Partnership and its 99%
owned partnerships which hold the individual properties.  All significant
inter-partnership balances and transactions have been eliminated.  The amount
of minority interest attributable to affiliates of the General Partner is
immaterial.

2. Cash and Cash Equivalents

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

The Partnership maintains cash accounts with a variety of unrelated banks, all
of which are covered by the Federal Deposit Insurance Corporation (FDIC).  At
December 31, 1996, the Partnership maintained cash balances at these banks
aggregating $683,595 in excess of the $100,000 FDIC insured maximum.


3. Operating Revenue

Operating revenue is recorded when services are rendered and includes amounts
reimbursable by the Medicaid and Medicare programs.  Medicaid and Medicare
revenues are recorded at the applicable net reimbursement rates; therefore, no
contractual adjustments are reported.

The Partnership grants unsecured credit to the residents of its facilities.
Inherent in this practice is a credit risk of non-collection.  Management has
provided an allowance which it believes will be sufficient to absorb all
uncollectible amounts existing at December 31, 1996 and 1995, respectively.





                                       21
<PAGE>   22


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

3. Operating Revenue continued

Accounts receivable consist primarily of amounts due from residents funded
through Medicare, Medicaid, commercial insurance and private resources.

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

The sources of patient revenues for years ended December 31, 1996, 1995 and
1994 are:
<TABLE>
<CAPTION>
                                    1996        1995        1994
                                  --------    --------    --------
<S>                                  <C>         <C>         <C>
Medicaid                              49%         58%         65%
Private Pay                           12%         13%         14%
VA, Medicare and Other                39%         29%         21%
                                      ---        ----        ----
                                     100%        100%        100%
                                    =====       =====       =====
</TABLE>


The significant components of accounts receivable at December 31, 1996 and 1995
are:
<TABLE>
<CAPTION>
                                            1996       1995
                                           ------     ------
    <S>                                     <C>        <C>
    Medicaid                                 47%        47%
    Private Pay                               9%        10%
    VA, Medicare & Other                     44%        43%
                                          ------     ------
                                            100%       100%
                                          ======     ======
</TABLE>

Payments by both the state and federal governments are normally received within
60-90 days. During the third quarter revenue was decreased by approximately
$125,000 representing cost report settlements in excess of estimated amounts
previously recorded.

4. Property and Equipment

Property and equipment are depreciated using the straight-line method over
lives of 5 to 30 years.  Amortization of Leased Assets is included in
depreciation and amortization expense.  Renewals and betterment are capitalized
and repairs and maintenance are charged to operations as incurred.

Effective January 1, 1996, the Partnership recognizes impairment losses on
property and equipment in accordance with the Statement of Financial Accounting
Standards No. 121 - "Accounting for the Impairment of Long-Lived Assets and for
Long- Lived Assets to be Disposed of". Since the Partnership has recognized
impairment losses, as discussed in Notes F and G, effectively adjusting the
carrying value of its long-lived assets to estimated net realizable value as of
December 31, 1994, which has been further depreciated during 1995 and 1996, no
significant adjustment of carrying value at December 31, 1996 to the lower of
carrying value or fair value is currently required. Prior to 1996, the
Partnership recognized an impairment loss on operating property and equipment
of its long-term care facilities when it became probable that the carrying
amount of the facility would not be recoverable through future operations.
Write downs were charged to operations for the difference in the net carrying
value and the estimated undiscounted future cash flows before interest charges
of the facility.

Upon the determination that a facility will be abandoned, foreclosed, placed on
the market for sale, or otherwise disposed of, the facility's carrying value is





                                       22
<PAGE>   23


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

4. Property and Equipment continued

adjusted to the estimated fair value, if less than carrying value, through a
charge to operations.  See Note G.

5. Income Taxes

No provision has been made in the financial statements for income taxes because
under current law, no income taxes are paid directly by the Partnership.  The
Partnership reports certain transactions differently for tax and financial
statement purposes.

6. Allocation of Net Income or Net Loss and Distributions

The Partnership Agreement provides that net income (other than net income from
a sale or refinancing of Partnership property), will be allocated to the
Partners in proportion to cash distributions.  Net losses will be allocated 99%
to the Limited Partners and 1% to the General Partner.

Net profits from a sale or refinancing of Partnership property will be
allocated first to any partners in proportion to and to the extent of their
negative adjusted capital accounts; then in accordance with distributions of
sale proceeds, refinancing proceeds and cash from other sources.

Distributions of cash from operations are made as follows:

(a)   First, to the Limited Partners until they have received distributions of
      cash from operations equal to a prescribed (7% through April 1, 1990, and
      9% thereafter in compliance with the Quest Proxy and the Amendment to the
      Partnership Agreement) non-cumulative return on their invested capital;
      then,

(b)   to the General Partner in the amount of distribution advances, if any,
      previously advanced; then,

(c)   to the General Partner until it has received cash from operations equal
      to 4% of the total distributions of cash from operations; then,

(d)   96% to the Limited Partners and 4% to the General Partners.

Distributions of cash from the sale or refinancing of properties will be
distributed as follows:

(a)    First, to all Limited Partners until they have received distributions
       from all sources equal to their priority return not previously
       distributed through distributions of cash from operations; then,

(b)    to the General Partner in the amount of distribution advances, if any,
       previously advanced; then,

(c)    to all Limited Partners until they have received distributions of cash
       from property sales and refinancing and cash from other sources equal to
       their original capital investment; then,





                                       23
<PAGE>   24


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS


6. Allocation of Net Income or Net Loss and Distributions continued


(d)    to the General Partner until it has received distributions equal to 1%
       of the distributions to the Limited Partners other than in a return of
       the Limited Partners' original capital investment or in the payment of
       distribution advances to the General Partner; then,

(e)    85% to the Limited Partners and 15% to the General Partner.


7. Net Income (Loss) Per Limited Partnership Unit

Net income (loss) per Limited Partnership Unit is computed by dividing net
income (loss) allocated to the Limited Partners by the weighted average number
of Limited Partnership Units outstanding.


8. Use of Estimates

The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts in the balance sheets and
statements of operations.  Actual results could differ from those estimates.

9. Fair Value of Financial Instruments

During 1995, the Company adopted Statement of Financial Accounting Standards
No. 107, "Disclosures about Fair Value of Financial Instruments," which
requires disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet.

The carrying value of cash and cash equivalents, approximate fair value due to
the short-term nature of these instruments.  There are no off-balance sheet
financial instruments to which the Partnership is subject.

NOTE B TRANSACTIONS WITH AFFILIATES

The Partnership Agreement provides for payment of property management fees
based on 6% of gross property operating revenue.  Quest Administrative
Services, L.P. (QASLP), an affiliate of Quest, receives 1% of gross property
operating revenue relating to services provided directly to the facilities.
Total payments to QASLP under these contracts in 1996, 1995 and 1994 and were
$67,057, $113,966 and $191,258, respectively.

Quest, in an effort to continue certain health benefits for employees, created
an employee benefit trust (the "Trust") in compliance with the guidelines
promulgated by VEBA and ERISA.  Amounts contributed to the Trust by the
Partnership and Partnership employees are strictly for the benefit of employees
of the participating employers, payment of excess loss reinsurance, life
insurance and accidental death and dismemberment and claims and plan
administration and employee medical claims.  Quest has engaged a claims pre-
certification organization to review all claims made by the Partnership's





                                       24
<PAGE>   25


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

NOTE B TRANSACTIONS WITH AFFILIATES continued

employees.  Approximately $135,120, $198,210, and $249,065 was recorded under
this arrangement in 1996, 1995, and 1994, respectively.

Partnership administration costs paid through QASLP were $387,724, $579,408,
and $630,987 in 1996, 1995, and 1994, respectively.  Such charges represent
legal costs associated with litigation and SEC filings, investor service
functions and other partnership administration costs.

NOTE C  LONG-TERM OBLIGATIONS

A summary of the long-term obligations of the Partnership at December 31, 1996
and 1995 follows:
<TABLE>
<CAPTION>
                                                                         1996            1995
                                                                     ------------    ------------
<S>                                                                 <C>              <C>
13.75% installment notes related to four
vans in 1994 and to one in 1995 collateralized
by the vehicles.  Monthly payments of principal
and interest of $398.  Notes are due
May, 1997.                                                               7,705           18,267

9.5% installment notes related to five vans in
1994 and to two in 1995, collateralized by the
vehicles.  Monthly payments of principal and
interest of $998.  Notes are due August, 1997                            1,924            6,116
                                                                     ---------        ---------
                                                                         9,629           24,383
Less current maturities                                                  9,629           14,754
                                                                     ---------        ---------
Long-term portion                                                   $        -       $    9,629
                                                                     =========        =========
</TABLE>

NOTE D  LITIGATION


During the third quarter of 1994, the Partnership settled its litigation with
Healthcare Services Group, Inc., with $64,012 being recognized as a non-cash
extraordinary gain for 1994.

In 1994, a complaint associated with a sexual harassment and wrongful
termination was filed against the Partnership. In the fourth quarter of 1996, a
complaint for discrimination and wrongful termination was received by one of
the Partnership's facilities.   The Partnership's liability, if any, is not
determinable at this time and no provision has been made in the accompanying
Financial Statements.  It is the opinion of management that the ultimate
resolution will not have a material effect on the Partnership's financial
position. There has been no significant change in the status of this
litigation.





                                       25
<PAGE>   26


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS

NOTE D LITIGATION continued


In December 1994, the Partnership received a Notice and Demand for Payment from
the Idaho State Tax Commission resulting from sales tax audits for the years
1976 through 1988 under a theory of successor liability for approximately
$470,000.  The Partnership has recorded a provision in the 1994 Financial
Statements for $352,602, at December 31, 1994.  As a result of selling certain
facility interests in 1995, this successor liability was reduced to
approximately $373,000 and the reserves were reduced to $279,691. As of year
end 1996 the reserve remains as $279,691. The amount of this liability could
change in the near term and the difference between the final settlement and the
recorded liability of $279,691 will be reflected in the results from
operations. As of year end 1996, the state was reassessing their position
relative to these claims.

NOTE E  TAXABLE LOSS

A reconciliation between the net income (loss) for financial reporting purposes
and the taxable income (loss) for income tax purposes follows:


<TABLE>
<CAPTION>
                                                                    Year Ended December 31,
                                                             1996             1995             1994
                                                          ----------       ----------       ----------
<S>                                                      <C>              <C>              <C>
Financial statement net income (loss)                    $ (618,694)      $   533,537      $(7,146,189)

Add:
  Bad debts                                                   8,495                 -           61,747
  Write down of properties                                        -                 -        7,180,571
  Jobs tax credit                                                 -                 -           72,134
  Prior year expense accrual                                (11,203)         (369,512)         369,512

  Current year expense accrual                                9,284            11,203                -
Deduct:
  Minority interest                                           4,272             2,171           (8,631)
  Excess of tax over book depreciation                     (186,071)         (248,609)        (184,847)
  Excess of tax over book basis
  of disposed facilities                                          -        (6,653,391)               -
  Bad debts                                                       -
                                                                             (121,298)               -
  Other                                                           -             2,023                -
                                                           --------         ----------       ---------
Taxable income (loss)                                    $ (793,917)      $(6,843,876)      $  344,297
                                                          =========        ==========        =========
</TABLE>





                                       26
<PAGE>   27

                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS


NOTE F IMPAIRMENT LOSS

Consistent with the Partnership's accounting policy as described in Note A, the
Partnership reflected the property and equipment as of December 31, 1994 at the
lower of cost (as previously adjusted for writedowns if applicable) or
estimated net realizable value at that date, determined on an individual
nursing home basis.  Writedowns of $762,797 and $1,518,905 were applied to
Valley Living Center and Valley Convalescent Center, respectively, which
represented Management's opinion of the excess carrying value at that date over
the estimated net realizable value of these two properties. The remaining
facilities, except the Church Hill facility, were also adjusted to estimated
net realizable value, resulting in an additional writedown of $4,898,869 (Note
G).  No further adjustments are believed necessary in 1996.

NOTE G SALE OF FACILITIES

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

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

The balance sheet of the Partnership reflects the effects of the sale of the
Partnership's interests in the five facilities.  The Partnership is seeking to
liquidate the Partnership's interests in its three remaining facilities.
Distributions of $2,792,780 or $10/unit were made to the limited partners in
March of 1995 and $2,513,502 or $9/unit were made in June 1995.





                                       27
<PAGE>   28


                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS





NOTE H PRO FORMA INFORMATION (UNAUDITED)

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

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


                PRO FORMA CONDENSED STATEMENT OF OPERATIONS (B)
                      For the Year Ended December 31, 1995
                            (Unaudited in thousands)

<TABLE>
<CAPTION>
                                                Historical               Adjustments               Pro Forma
                                              --------------           --------------            -------------
<S>                                             <C>                  <C>                         <C>
Revenues:                                        $    12,012          $   (5,300)  (A)           $       6,712
                                                     -------              -------                      -------

Expenses:
 Wages and salaries                             $      5,518         $    (2,537)  (A)           $       2,981
 Operating expenses                                    4,913              (2,140)  (A)                   2,773
 Management fees                                         618                (287)  (A)                     331
 Management fees-affiliate                               114                 (48)  (A)                      66
 Property taxes and interest                             111                 (52)  (A)                      59
 Depreciation and amortization                           174                 (92)  (A)                      82
 Partnership administration                              579                                               579
                                                      ------             -------                         -----
                                                      12,027              (5,156)                        6,871
                                                      ------              -------                       ------

Net income (loss) (B)                           $        (15)         $      144                   $      (159)
                                                      ======             =======                         =====
</TABLE>



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

(B)      The historical statement of operations for the period ended December
         31,  1995 includes a gain of $548, in thousands, from the sale of five
         facilities.  This amount is not included in the above pro forma
         condensed statement of operations due to its non recurring nature.





                                       28
<PAGE>   29

                        QUEST HEALTH CARE FUND VII, L.P.
                         NOTES TO FINANCIAL STATEMENTS


NOTE I GOING CONCERN

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

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

NOTE J  SUBSEQUENT EVENT

Subsequent to December 31, 1996, the Partnership entered into a contract with
an unaffiliated third party to sell all of the assets of one of its subsidiary
partnerships.  The contract calls for all cash consideration to be paid at the
date of closing.  The Partnership will distribute the proceeds of sale, should
the sale be completed, as part of its final liquidation.





                                       29
<PAGE>   30




                        QUEST HEALTH CARE FUND VII, L.P.
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
              For the Years Ended December 31, 1996, 1995 and 1994





<TABLE>
<CAPTION>
                                                              Additions     Receivables     Write-off of
                                             Balance at       Charged to    Charged         Allowance
                                             Beginning        Costs and     Against         for Sold         Balance at
Description                                  of Period        Expenses      Allowances      Facilities       End of Period
-----------                                  ---------        ---------     ----------      ----------       -------------
<S>                                        <C>                <C>              <C>              <C>              <C>
Year ended December 31, 1996
----------------------------

Allowance for
  doubtful accounts                        $  25,000        $   30,000       $  (21,505)      $        -       $   33,495
                                            ========         =========        =========        =========        =========



Year ended December 31, 1995
----------------------------

Allowance for
  doubtful accounts                        $ 262,636        $   17,265       $  (53,570)      $(201,331)       $   25,000
                                             ========         =========        =========        ========         =========




Year ended December 31, 1994
----------------------------

Allowance for
  doubtful accounts                        $ 246,153        $  103,387       $  (86,904)      $       -        $ 262,636
                                            ========         =========        =========        ========         ========
</TABLE>





                                       30
<PAGE>   31

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

The Partnership has had no disagreement with its accountants on accounting or
financial issues during the past three years.

                                    PART III

ITEM 10  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The Partnership does not have officers or directors. Quest became the general
partner of the Partnership on August 1, 1990. The general partner of Quest is
Quest Rescue Partners - 7 Corp.  The principal officers and directors of the
general partner of Quest are as follows:


<TABLE>
<CAPTION>
                                               Other Principal Occupations and Other
Name and Position                     Age      Directorships During the Past 5 Years
-----------------                     ---      -------------------------------------
<S>                                   <C>      <C>
Stuart C. Berry                       43
  Chairman, President &
  Secretary                                    Chairman of Quest Financial Corp. and the Quest
                                               Affiliates, and has been since their inception in 1989.  Assumed position
                                               of President in the fourth quarter of 1996.  Mr. Berry received a B.S.
                                               degree in Finance from Babson College, Wellesley, Massachusetts in l976.
</TABLE>

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

ITEM 11  EXECUTIVE COMPENSATION

None of the executive officers of the general partner of Quest receive any
direct remuneration from the Partnership.  Quest is not compensated directly
for its services as General Partner of the Partnership.  See Item 13 for
further discussion of compensation paid to affiliates of SIG and Quest.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

(A)    Security ownership of certain beneficial owners.

       No person or groups, as defined by Section 13(d)(3) of the Securities
       Exchange Act of 1934, known to the Partnership is the beneficial owner
       of more than 5% of the Units.

(B)    Security ownership of management.

       No officer or director of the corporate general partner of Quest
       possesses a right to acquire beneficial ownership of any Units.





                                       31
<PAGE>   32


       Quest is entitled to distributions of cash from operations and from
       "other sources" (primarily from the sale or refinancing of Partnership
       properties, as set forth in Item 6, Note A.)

(C)    Change in control.

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

ITEM 13  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

(A) and (B)  Affiliates of the General Partner in accordance with the terms of
the  Agreement may receive compensation for services rendered to the
Partnership.

The independent management companies engaged by the Partnership receive a
management fee of 5% of gross operating revenues.  Quest Administrative
Services, L.P., an affiliate of Quest, receives a fee of 1% of gross operating
revenues for providing certain management services.  These fees are proscribed
in the Partnership Agreement and the structure permits a rapid and efficient
method of termination of a facility manager, should the need ever arise.  Total
payments to QASLP under this agreement in 1996 were $67,057.  Quest created an
employee benefit trust in compliance with the guidelines promulgated by VEBA
and ERISA.  Approximately $135,120 was recorded under this arrangement in 1996.
See Note B to the accompanying consolidated financial statements appearing in
Item 8.

(C)    No management persons are indebted to the Partnership.

(D)    There have been no significant transactions with promoters.


ITEM 14  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K


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

       1.  Consolidated Financial Statements:

           Report of Independent Accountants

           Consolidated Balance Sheets as of December 31, 1996 and 1995

           Consolidated Statements of Operations
             for the Years Ended December 31, 1996, 1995 and 1994

           Consolidated Statements of Partners' Equity
             for the Years Ended December 31, 1996, 1995 and 1994

           Consolidated Statements of Cash Flows
             for the Years Ended December 31, 1996, 1995 and 1994

           Notes to Consolidated Financial Statements





                                       32
<PAGE>   33

       2.  Financial Statement Schedules


             Schedule II - Valuation and Qualifying Accounts
               for the Years Ended December 31, 1996, 1995 and 1994



Other schedules are omitted since they are not required, are not applicable or
the financial information required is included in the consolidated financial
statements or notes thereto.


       3.  Exhibits

       The following exhibits are filed or incorporated by reference and are an
                       integral part of this Form 10-K.

<TABLE>
<CAPTION>
       Exhibit Number                 Document Description
       --------------                 --------------------
             <S>                       <C>
             2                        Agreement of Purchase and Sale between persons and entities set forth on Exhibit
                                      A, attached thereto, and Southmark Corporation dated as of April 1, 1987,
                                      incorporated by reference to Form 8-K dated June 30, 1987.

             2                        Assignment of Purchase and Sale Agreement between Southmark Corporation and the
                                      Limited Partnerships set out on Exhibit A, attached thereto, dated June 30, 1987
                                      incorporated by reference to Form 8-K dated June 30, 1987.

             2                        Agreement for the Purchase and Sale of General Partner and Limited Partner
                                      Interest by and among Southmark Consolidated Resources Corporation of America,
                                      Rogersville Associates Limited Partnership and Southmark/CRCA Health Care Fund
                                      VII, L.P. dated June 1, 1988 incorporated by reference to Form 8-K dated June 30,
                                      1987.

             2                        Agreement for the Purchase and Sale of General Partner and Limited Partner
                                      Interest by and among Southmark Consolidated Resources Corporation of America,
                                      Church Hill Limited Partnership and Southmark/CRCA Health Care Fund VII, L.P.
                                      dated June 1, 1988 incorporated by reference to Form 8-K dated June 30, 1987.

             3                        Agreement of Limited Partnership of Southmark/CRCA Health Care Fund VII, L.P.,
                                      incorporated by reference to Form S-1, Page A-1, File No. 33-7443

             3                        Amendment to Agreement of Limited Partnership of Southmark/CRCA Health care Fund
                                      VII, L.P., dated August 1, 1990.
</TABLE>





                                       33
<PAGE>   34


<TABLE>
           <S>                        <C>
             3                        Second Amendment to Agreement of Limited Partnership of Southmark/CRCA Health Care
                                      Fund VII, L.P., dated August 1, 1990.

             3                        Form of Fourth Amendment to Agreement of Limited Partnership Southmark/CRCA Health
                                      Care Fund VII, L.P., dated June 1, 1992.

             10                       Health Care Center Consultant and Management Services Agreement between National
                                      Heritage Management, Inc. and Nampa Canyon associates Limited Partnership d/b/a
                                      Midland Care Center incorporated by reference to amended form 10-K fiscal year
                                      ended December 31, 1988.

             10                       Agreement for laundry and housekeeping services between American Services Company
                                      and Port Angeles Associates, L.P. d/b/a Port Angeles Care Center incorporated by
                                      reference to amended form 10-K for fiscal year ended December 31, 1988.

             10                       Nursing Home Management Agreement between Southmark/CRCA Health Care Fund VII,
                                      L.P. and LTCS, L.P. d/b/a VHA Long Term Care dated January 14, 1991, effective
                                      November 28, 1989.


             10                       Form of Amendment, effective March 1, 1992, to the Nursing Home Management
                                      Agreement between Southmark/CRCA Health Care Fund VII, L.P. and LTCS, L. P. dba
                                      VHA Long Term Care.

             10                       Assignment of Limited Partnership Interest Agreement for the Church Hill facility
                                      between Quest Health Care Fund VII, L.P. and International Health Corp.  Contract
                                      for sale of four facilities between Quest Health Care Fund VII, L.P. and Millenium
                                      Foundation, Inc.

             22                       List of majority owned partnerships.

             27                       Financial Data Schedule (for SEC use only).

</TABLE>


(B)    Reports on Form 8-K:
             None during the fourth quarter of 1996.

(C) An annual report for the fiscal year 1996 will be sent to the Limited
Partners subsequent to this filing and the Partnership will furnish copies of
such report to the Securities and Exchange Commission at that time.





                                       34
<PAGE>   35



                                   SIGNATURES


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




                                 QUEST HEALTH CARE
                                 FUND VII, L.P.


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

                                 By:  QUEST RESCUE PARTNERS - 7 CORP,
                                      General Partner

Date: March 31, 1997             By:/s/ Stuart C. Berry
     -------------------            --------------------------------
                                      Stuart C. Berry
                                      President


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




Date: March 31, 1997             /s/ Stuart C. Berry
     -------------------         --------------------------------
                                 Stuart C. Berry
                                 CEO/CFO of the
                                 General Partner of
                                 the General Partner.





                                       35