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

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

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

                     For the transition period from to .

                       Commission File Number: 0-25880

                           ILM II LEASE CORPORATION
            (Exact name of registrant as specified in its charter)

       Virginia                                             04-3248639
(State of organization)                                  (I.R.S.Employer
                                                        Identification No.)

265 Franklin Street, Boston, Massachusetts                         02110
---------------------------------------------------------------------------
    (Address of principal executive office)                      (Zip Code)

Registrant's telephone number, including area code:            (800) 342-5797
                                                               --------------

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

Securities registered pursuant to Section 12(g) of the Act:
                    Shares of Common Stock, $.01 Par Value
                               (Title of class)

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

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

Shares of common  stock  outstanding  as of August 31,  1996:  5,180,952.  The
aggregate  sales price of the shares sold was $500,000.  This does not reflect
market value.  There is no current market for these shares.

                     DOCUMENTS INCORPORATED BY REFERENCE
        Documents                                        Form 10-K Reference
Registration Statement on Form 10 of registrant              Part IV
dated July 20, 1995, as supplemented

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




<PAGE>


                           ILM II LEASE CORPORATION
                                1996 FORM 10-K

                              TABLE OF CONTENTS


Part   I                                                                 Page

Item  1       Business                                                   I-1

Item  2       Properties                                                 I-3

Item  3       Legal Proceedings                                          I-3

Item  4       Submission of Matters to a Vote of Security Holders        I-3


Part  II

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

Item  6       Selected Financial Data                                   II-1

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

Item  8       Financial Statements and Supplementary Data               II-4

Item  9       Changes in and Disagreements with Accountants on Accounting
                 and Financial Disclosure                               II-4


Part III

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

Item  11      Executive Compensation                                   III-2

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

Item  13      Certain Relationships and Related Transactions           III-3


Part  IV

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

Signatures                                                              IV-2

Index to Exhibits                                                       IV-3

Financial Statements and Supplementary Data                      F-1 to F-12


<PAGE>

                                    PART I

Item 1.  Business

      ILM II  Lease  Corporation  (the  "Company")  was  formed  by  PaineWebber
Independent  Living Mortgage Inc. II ("ILM"),  a publicly-held,  non-traded Real
Estate  Investment  Trust  ("REIT"),  for the  purpose of  operating  six Senior
Housing Facilities under the terms of a master lease agreement.  ILM contributed
$500,000 in return for all of the issued and outstanding shares of the Company's
common stock.  ILM had originally  made mortgage loans secured by the Facilities
to Angeles Housing  Concepts,  Inc.  ("AHC") between July 1990 and July 1992. In
March  1993,  AHC  defaulted  under  the  terms of such  mortgage  loans  and in
connection  with the  settlement of such default,  title to the  Facilities  was
transferred,  effective  April 1,  1994,  to  certain  majority-owned,  indirect
subsidiaries of ILM, subject to the mortgage loans.  Subsequently,  the indirect
subsidiaries of ILM were merged into ILM II Holding,  Inc. ("ILM  Holding").  As
part of the fiscal 1994  settlement  agreement with AHC, AHC was retained as the
property manager for all of the Senior Housing Facilities  pursuant to the terms
of a management  agreement  which was assigned to the Company as of September 1,
1995.  As discussed  further in Item 7, the  management  agreement  with AHC was
terminated in July 1996.

      ILM has elected to be taxed as a REIT under the  Internal  Revenue Code of
1986, as amended ("the Code"), for each taxable year of operations.  In order to
maintain  its  status  as a REIT,  75% of  ILM's  annual  gross  income  must be
Qualified  Rental Income as defined by the Code.  The rent paid by the residents
of the  Facilities  likely  would not be deemed to be  Qualified  Rental  Income
because of the extent of  services  provided  to  residents.  Consequently,  the
operation of the Facilities by ILM or its  subsidiaries  over an extended period
of time could adversely affect ILM's status as a REIT. Therefore, ILM formed the
Company to operate the Facilities,  and by means of a distribution,  transferred
the  ownership  of the common  stock of the Company to the holders of ILM common
stock.  Because the Company,  which is taxed as a regular C  corporation,  is no
longer a  subsidiary  of ILM,  it can  receive  service-related  income  without
endangering the REIT status of ILM. On September 1, 1995, after ILM received the
required  regulatory  approval,  it distributed all of the outstanding shares of
capital stock of the Company to the holders of record of ILM's common stock. One
share of common  stock of the  Company  was  issued for each full share of ILM's
common stock held.  No  fractional  shares were issued.  Holders of ILM's common
stock were not  required to pay any cash or other  consideration  or to exchange
their  common  stock of ILM for the common  stock of the  Company.  Prior to the
distribution of the Company's stock, ILM's shareholders  received an information
statement  fully  describing  the  Company and the  distribution  of its capital
stock.

      The master lease  agreement,  which  commenced  on  September 1, 1995,  is
between ILM Holding,  as owner of the properties and Lessor, and the Company, as
Lessee.  The master lease is a  "triple-net"  lease  whereby the Lessee pays all
operating  expenses,  governmental  taxes and  assessments,  utility charges and
insurance premiums, as well as the costs of all required  maintenance,  personal
property and  non-structural  repairs in  connection  with the  operation of the
Senior Housing  Facilities.  ILM Holding,  as the Lessor, is responsible for all
major  capital  improvements  and  structural  repairs  to  the  Senior  Housing
Facilities.  ILM  Holding,  as  the  Lessor,  is  responsible  for  all  capital
improvements and structural repairs to the Senior Housing Facilities. During the
initial term of the master lease,  which expires on December 31, 2000  (December
31, 1999 with respect to the Santa Barbara  Facility),  the Company is obligated
to pay annual base rent for the use of all of the  Facilities  in the  aggregate
amount  of  $3,548,700  for  calendar  year  1995  (prorated  based on the lease
commencement  date) and  $4,035,600  for calendar year 1996 and each  subsequent
year.  Beginning  in January 1997 and for the  remainder of the lease term,  the
Company  will also be obligated to pay  variable  rent for each  Facility.  Such
variable  rent will be payable  quarterly  and will equal 40% of the excess,  if
any, of the aggregate total revenues for the Facilities, on an annualized basis,
over $13,021,000.

    The  facilities  which the  Company  has  leased as of August  31,  1996 are
described below:

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

The Palms
Fort Myers, FL             Senior Housing Facility               204 Units



<PAGE>


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

Crown Villa
Omaha, NE                  Senior Housing Facility               73 Units

Overland Park Place
Overland Park, KS          Senior Housing Facility               137 Units

Rio Las Palmas
Stockton, CA               Senior Housing Facility               162 Units

The Villa at Riverwood
St. Louis County, MO       Senior Housing Facility               119 Units

Villa Santa Barbara (2)
Santa Barbara, CA          Senior Housing Facility               123 Units

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

(2) The  Santa  Barbara  facility  is  jointly  leased  by  the  Company  and an
    affiliated  company,  ILM I Lease  Corporation.  The Company and ILM I Lease
    Corporation  have entered into a joint tenancy  agreement  which governs the
    operation  of the property  and the  apportionment  of revenues and expenses
    between the parties.  Any amounts  generated by the  operations of the Santa
    Barbara  property are  equitably  apportioned  between the Company and ILM I
    Lease Corporation (generally 75% and 25%, respectively).

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

      Subject to the supervision of and pursuant to the general  policies set by
the  Company's  Board of  Directors,  assistance in managing the business of the
Company is provided by  PaineWebber  Lease  Advisor,  L.P.  (the  "Advisor"),  a
limited partnership comprised of ILM Lease Advisor, Inc., as the general partner
and Properties Associates, L.P., as the limited partner. ILM Lease Advisor, Inc.
is a wholly owned subsidiary of PaineWebber  Properties  Incorporated  ("PWPI").
The partners of the Advisor are affiliates of PaineWebber  Incorporated  ("PWI")
and PaineWebber Group, Inc. ("PaineWebber").

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

      The terms of  transactions  between  the  Company  and the Advisor and its
affiliates  are set forth in Items 11 and 13 below to which  reference is hereby
made for a description of such terms and  transactions.  As discussed further in
Item 7, the Company has retained  Capital  Senior  Management 2, Inc. of Dallas,
Texas ("Capital"),  to be the new manager of the Senior Housing Facilities.  The
management  contract with Capital was executed in July 1996.  In November  1996,
Lawrence A. Cohen,  a director of the  Company and  President,  Chief  Executive
Officer and Director of ILM, became Vice Chairman and Chief Financial Officer of
Capital  Senior  Living  Corp.,  an  affiliate  of  Capital.  As a  result,  the
management  contract with Capital is considered a related party transaction (see
Item 13).



<PAGE>


Item 2.  Properties

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

      Occupancy  figures  for each fiscal  quarter  during  1996,  along with an
average for the year, are presented below for each property:

                                             Percent Leased At
                              ------------------------------------------------
                                                                       Fiscal
                                                                       1996
                              11/30/95   2/29/96    5/31/96   8/31/96  Average
                              --------   -------    -------   -------  -------

The Palms                      99%       100%       99%       99%       99%

Crown Villa                    98%        97%       96%       99%       98%

Overland Park Place            98%        95%       91%       91%       94%

Rio Las Palmas                 75%        79%       85%       90%       82%

The Villa at Riverwood         95%        95%       93%       94%       94%

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

Item 3.  Legal Proceedings

      On July 29, 1996, the Company and ILM II Holding,  Inc. ("the  Companies")
terminated the property management agreement with Angeles Housing Concepts, Inc.
("AHC") covering the six senior housing  facilities  leased by the Company.  The
management agreement was terminated for cause pursuant to Sections 1.05 (a) (i),
(iii) and (iv) of the  agreement.  Simultaneously  with the  termination  of the
management agreement, the Companies,  together with certain affiliated entities,
filed suit  against  AHC in the United  States  District  Court for the  Eastern
District of Virginia for breach of contract, breach of fiduciary duty and fraud.
The  Company  and ILM  Holding  allege  that  AHC  willfully  performed  actions
specifically  in violation  of the  management  agreement  and that such actions
caused  damages to the  Companies.  Due to the  termination of the agreement for
cause, no termination fee was paid to AHC.  Subsequent to the termination of the
management  agreement,  AHC filed for  protection  under  Chapter 11 of the U.S.
Bankruptcy  Code in its domestic state of California.  The filing was challenged
by the  Companies,  and the  Bankruptcy  Court  dismissed  AHC's case  effective
October 15, 1996. In November 1996,  AHC filed with the Virginia  District Court
an Answer  in  response  to the  litigation  initiated  by the  Companies  and a
Counterclaim  against ILM Holding.  The Counterclaim alleges that the management
agreement was wrongfully terminated for cause and requests damages which include
the  payment  of the  termination  fee in the  amount of  $750,000,  payment  of
management fees pursuant to the contract from August 1, 1996 through October 15,
1996,  which is the earliest date that the management  agreement could have been
terminated  without  cause,  and  recovery  of  attorney's  fees  and  expenses.
PaineWebber  Independent  Living  Mortgage Inc. II guaranteed the payment of the
termination  fee  at  issue  in  these  proceedings.  The  Companies  intend  to
diligently prosecute the case and to vigorously defend the counterclaims made by
AHC.  The  eventual  outcome of this  termination  dispute  cannot  presently be
determined.

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

    None.


<PAGE>


                                   PART II

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

      Prior to September 1, 1995, the Company was a  wholly-owned  subsidiary of
ILM. Pursuant to a Reorganization  and Distribution  Agreement,  ILM capitalized
the Company  with  $500,000,  an amount  estimated  to provide the Company  with
necessary working capital.  On September 1, 1995,  Mavricc  Management  Systems,
Inc., as the distribution agent, caused to be issued on the stock records of the
Company the distributed Common Stock of the Company, in uncertificated  form, to
the  holders of record of ILM common  stock at the close of business on July 14,
1995.  One  share  of the  Company's  Common  Stock  was  distributed  for  each
outstanding  share of ILM Common Stock. No  certificates  or scrip  representing
fractional  shares of the  Company's  Common Stock were issued to holders of ILM
common  stock  as part of the  distribution.  In  lieu of  receiving  fractional
shares,  each holder of ILM common stock who would  otherwise have been entitled
to receive a fractional  share of the  Company's  Common  Stock  received a cash
payment  equivalent to $0.14 per share for such fractional  interest.  At August
31, 1996, there were 3,578 record holders of the Company's shares.

      The Company did not pay cash dividends in fiscal 1996. The Company intends
to review this policy  during  fiscal 1997,  and may or may not determine to pay
cash  dividends  in the future.  Payment of  dividends,  if any,  will be at the
discretion of the Company's Board of Directors and will depend upon such factors
as the Company's  financial  condition,  earnings,  anticipated  investments and
other relevant factors.

Item 6.  Selected Financial Data

                           ILM II Lease Corporation
                    (In thousands, except per share data)

                                                        Period from
                                                        September 12, 1994
                                 For the year ended    (date of inception)
                                 August 31, 1996        through August 31, 1995
                                 ---------------        -----------------------

Revenues                           $13,201                 $       -

Income (loss) before income taxes  $   433                 $      (1)

Income tax expense                 $   173                         -

Net income (loss)                  $   260                 $      (1)

Net income (loss) per share 
 of common stock                   $   0.05                $    (0.07)

Total assets                       $  1,935                         -

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

    The above net  income  (loss)  per share of common  stock is based  upon the
weighted average number of shares outstanding for the year ended August 31, 1996
and the period September 12, 1994 (inception) through August 31, 1995 (5,180,952
and 15,000, respectively).


<PAGE>


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

Liquidity and Capital Resources

      ILM II  Lease  Corporation  (the  "Company")  was  formed  by  PaineWebber
Independent  Living Mortgage Inc. II ("ILM"),  a publicly-held,  non-traded Real
Estate  Investment  Trust  ("REIT"),  for the  purpose of  operating  six Senior
Housing Facilities under the terms of a master lease agreement.  ILM contributed
$500,000 in return for all of the issued and outstanding shares of the Company's
common stock.  ILM had originally  made mortgage loans secured by the Facilities
to Angeles Housing  Concepts,  Inc.  ("AHC") between July 1990 and July 1992. In
March  1993,  AHC  defaulted  under  the  terms of such  mortgage  loans  and in
connection  with the  settlement of such default,  title to the  Facilities  was
transferred,  effective  April 1,  1994,  to  certain  majority-owned,  indirect
subsidiaries of ILM, subject to the mortgage loans. Subsequently, these indirect
subsidiaries were merged into ILM II Holding, Inc. ("ILM Holding") which is also
a  majority-owned  subsidiary  of ILM.  As part of the  fiscal  1994  settlement
agreement  with AHC,  AHC was  retained as the  property  manager for the Senior
Housing  Facilities  pursuant to the terms of a management  agreement  which was
assigned to the Company as of September 1, 1995. As discussed further below, the
management agreement with AHC was terminated in July 1996.

      ILM has elected to be taxed as a REIT under the  Internal  Revenue Code of
1986, as amended ("the Code"), for each taxable year of operations.  In order to
maintain  its  status  as a REIT,  75% of  ILM's  annual  gross  income  must be
Qualified  Rental Income as defined by the Code.  The rent paid by the residents
of the  Facilities  likely  would not be deemed to be  Qualified  Rental  Income
because of the extent of  services  provided  to  residents.  Consequently,  the
operation of the Facilities by ILM or its  subsidiaries  over an extended period
of time could adversely affect ILM's status as a REIT. Therefore, ILM formed the
Company to operate the Facilities,  and by means of a distribution,  transferred
the  ownership  of the common  stock of the Company to the holders of ILM common
stock.  Because the Company,  which is taxed as a regular C  corporation,  is no
longer a  subsidiary  of ILM,  it can  receive  service-related  income  without
endangering the REIT status of ILM. On September 1, 1995, after ILM received the
required  regulatory  approval,  it distributed all of the outstanding shares of
capital stock of the Company to the holders of record of ILM's common stock. One
share of common  stock of the  Company  was  issued for each full share of ILM's
common stock held.  No  fractional  shares were issued.  Holders of ILM's common
stock were not  required to pay any cash or other  consideration  or to exchange
their  common  stock of ILM for the common  stock of the  Company.  Prior to the
distribution of the Company's stock, ILM's shareholders  received an information
statement  fully  describing  the  Company and the  distribution  of its capital
stock.

      The master lease  agreement,  which  commenced  on  September 1, 1995,  is
between ILM Holding,  as owner of the properties and Lessor, and the Company, as
Lessee.  The master lease is a  "triple-net"  lease  whereby the Lessee pays all
operating  expenses,  governmental  taxes and  assessments,  utility charges and
insurance premiums, as well as the costs of all required  maintenance,  personal
property and  non-structural  repairs in  connection  with the  operation of the
Senior Housing  Facilities.  ILM Holding,  as the Lessor, is responsible for all
major  capital  improvements  and  structural  repairs  to  the  Senior  Housing
Facilities.  During the  initial  term of the  master  lease,  which  expires on
December  31,  2000  (December  31,  1999  with  respect  to the  Santa  Barbara
Facility),  the Company is  obligated to pay annual base rent for the use of all
of the  Facilities in the aggregate  amount of $3,548,700 for calendar year 1995
(prorated based on the lease commencement date) and $4,035,600 for calendar year
1996 and each subsequent  year.  Beginning in January 1997 and for the remainder
of the lease term,  the Company will also be obligated to pay variable  rent for
each Facility.  Such variable rent will be payable  quarterly and will equal 40%
of the excess, if any, of the aggregate total revenues for the Facilities, on an
annualized basis, over $13,021,000.

     At the present time,  ILM Holding is not expected to have  sufficient  cash
flow during  fiscal 1997 to (i) meet its  obligations  to make the debt  service
payments  due  under  its  mortgage   loans  with  ILM,  (ii)  pay  for  capital
improvements  and structural  repairs in accordance with the terms of the master
lease,  and  (iii)  pay  for  costs  that  may be  incured  in  defending  AHC's
Counterclaim  against ILM Holding, as discussed further below. If ILM Holding is
unable to complete its  restructuring  plans,  as  described in the  information
statement  referred to above, due to PWPI's refusal to cause PWP Holding to sell
to ILM its voting stock in ILM Holding, ILM Holding may be unable to perform its
obligations under the master lease.

      As noted  above,  the  Company's  master  lease is  scheduled to expire on
December 31, 2000. This period  coincides with the end of ILM's expected holding
period for its  investments  in the  Facilities.  While such  holding  period is
subject to change, the current Articles of Incorporation of ILM provide that the
liquidation  of ILM must be  completed by no later than  December 31, 2005.  Any
further  renewals of the master lease beyond  December  2000 would be subject to
negotiation  between  the  Company  and  ILM  and  its  consolidated  affiliate.
Accordingly, since the Company does not have any current plans to operate or own
any other facilities or engage in any other business outside of its relationship
with ILM, there are no assurances  that the Company's  operations  will continue
beyond December 2000.

      On July 29, 1996, the Company and ILM Holding ("the Companies") terminated
the property  management  agreement  with AHC  covering  the six senior  housing
facilities  leased by the Company.  The management  agreement was terminated for
cause pursuant to the terms of the contract. Simultaneously with the termination
of the management  agreement,  the Companies,  together with certain  affiliated
entities,  filed suit against AHC in the United  States  District  Court for the
Eastern  District of Virginia for breach of contract,  breach of fiduciary  duty
and fraud.  The  Company and ILM Holding  allege  that AHC  willfully  performed
actions  specifically  in violation of the  management  agreement  and that such
actions caused damages to the Companies. Due to the termination of the agreement
for cause, no termination fee was paid to AHC.  Subsequent to the termination of
the management agreement,  AHC filed for protection under Chapter 11 of the U.S.
Bankruptcy  Code in its domestic state of California.  The filing was challenged
by the  Companies,  and the  Bankruptcy  Court  dismissed  AHC's case  effective
October 15, 1996. In November 1996,  AHC filed with the Virginia  District Court
an Answer  in  response  to the  litigation  initiated  by the  Companies  and a
Counterclaim  against ILM Holding.  The Counterclaim alleges that the management
agreement was wrongfully terminated for cause and requests damages which include
the  payment  of the  termination  fee in the  amount of  $750,000,  payment  of
management fees pursuant to the contract from August 1, 1996 through October 15,
1996,  which is the earliest date that the management  agreement could have been
terminated  without  cause,  and recovery of attorney's  fees and expenses.  ILM
guaranteed the payment of the termination fee at issue in these proceedings. The
Companies intend to diligently  prosecute the case and to vigorously  defend the
counterclaims  made by AHC. The  eventual  outcome of this  termination  dispute
cannot  presently be  determined.  Accordingly,  no provision  for any liability
which might  result  from the  outcome of this  matter has been  recorded in the
accompanying financial statements.

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

      The six properties  which the Company leases from ILM Holding averaged 93%
occupancy as of August 31, 1996.  The Facilities  generated  sufficient net cash
flow to cover the master lease rental  obligation during the initial year of the
Company's operation. In addition, current annualized operating income levels are
sufficient to cover the base master lease  payments at their current  annualized
level of $4,035,600,  which will remain in effect  throughout the remaining term
of the lease. As noted above,  the master lease also provides for the payment of
variable  rent  beginning in January 1997.  The Senior  Housing  Facilities  are
currently  generating  gross  revenues  which  are  slightly  in  excess  of the
specified  threshold  in the variable  rent  calculation,  as discussed  further
above. Accordingly,  the Company expects that it will owe variable rent payments
to ILM Holding in fiscal 1997. Further improvement in operating income levels is
expected  upon the  lease-up of the Villa  Santa  Barbara  property.  A property
renovation and assisted-living  conversion program has been in progress at Villa
Santa Barbara for the past two years.  Phase one of the renovations at the Santa
Barbara Facility, which was completed during fiscal 1995, included renovation of
the lobby, dining room, library,  activities room,  television and game room and
the laundry rooms. Phase two of the renovation program,  which was substantially
completed  during  the first  quarter of fiscal  1996,  involved  interior  unit
improvements,  hallway  upgrades and the conversion of existing  studio units to
assisted   living  units.   The  total  cost  of  the  renovation   program  was
approximately  $1.2  million,  which  has been  funded  75% by ILM and 25% by an
affiliated  company,  PaineWebber  Independent  Living Mortgage Fund, Inc., from
funds previously reserved for such improvements.  Leasing gains at Santa Barbara
have been  slowed  by  delays in  completing  the  capital  improvements  and in
obtaining  the required  regulatory  licensing to begin leasing the new assisted
living units.  During the quarter ended May 31, 1996,  the Company  received the
required  assisted living licenses.  Leasing of the 38 new assisted living units
is now well underway.  Overall occupancy of Villa Santa Barbara averaged 81% for
the fourth  quarter  of fiscal  1996.  The  Company,  together  with ILM and its
consolidated  affiliate,  is currently investigating the potential for expansion
of the assisted  living  capacities  at properties in other markets where demand
for assisted living units is particularly high.

      At  August  31,  1996,  the  Company  had  cash and  cash  equivalents  of
$1,591,000.  Such  amounts  will  be  used  for the  Company's  working  capital
requirements. As noted above, under the terms of the master lease, the Lessor is
responsible  for any major capital  improvements  or  structural  repairs to the
Senior Housing Facilities.  Consequently, the Company does not have any material
commitments  for  capital  expenditures.   Furthermore,  the  Company  does  not
currently  anticipate  the need to  engage  in any  borrowing  activities.  As a
result,  substantially  all of the  Company's  cash flow will be generated  from
operating activities. The Company did not pay cash dividends in fiscal 1996. The
Company  intends to review this policy  during  fiscal 1997,  subsequent  to the
commencement of the variable rent payments  discussed  further above, and may or
may not determine to pay cash dividends in the future. Payment of dividends,  if
any,  will be at the  discretion  of the  Company's  Board of Directors and will
depend  upon  such  factors  as the  Company's  financial  condition,  earnings,
anticipated  investments  and  other  relevant  factors.  The  source  of future
liquidity  is expected to be from  operating  cash flow from the Senior  Housing
Facilities, net of the master lease payments to ILM Holding, and interest income
earned on invested cash  reserves.  Such sources of liquidity are expected to be
adequate to meet the Company's  operating  requirements on both a short-term and
long-term basis.

Results of Operations
1996 Compared to 1995

    Prior to the  commencement  of the master  lease  agreement  on September 1,
1995,  the Company had no significant  operating  activities.  As a result,  the
comparison of fiscal 1996 results to any prior period is not relevant.

Inflation

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

      Inflation in future periods is likely to cause  increases in the Company's
expenses, which may be partially offset by increases in revenues from the tenant
leases at the Senior Housing  Facilities.  Rental revenues may tend to rise with
inflation  since the rental rates on the tenant leases,  which are short-term in
nature,  can be adjusted to keep pace with inflation as market conditions allow.
As noted  above,  under the terms of the  master  lease  agreement  between  the
Company and ILM II Holding, Inc., the Company is obligated to pay variable rent,
in  addition to the base rent owed,  in an amount  equal to 40% of the excess of
total revenues from the Facilities over a specified base amount. Accordingly, to
the extent that the total revenues are in excess of this threshold, a portion of
the increase in revenues would be payable to the Lessor.

Item 8.  Financial Statements and Supplementary Data

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

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

      None.


<PAGE>

                                   PART III

Item 10.  Directors and Executive Officers of the Registrant

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

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

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

John B. Watts III            President and Director            43     9/13/94 *
Lawrence A. Cohen            Director                          43     9/13/94 *
Jeffry R. Dwyer              Director                          50     9/13/94 *
David F. Brooks              Vice President and Secretary      54     9/13/94 *
Timothy J. Medlock           Treasurer                         35     9/13/94 *
Valda M. Webster Kreie       Assistant Secretary               45     9/13/94 *

*  The date of incorporation of the Company.

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

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

Bruce J. Rubin          President and Chief Executive Officer  37
David F. Brooks         Vice President and Secretary           54
Timothy J. Medlock      Vice President and Treasurer           35
Valda M. Webster Kreie  Assistant Secretary                    45

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

    (e)  The  business  experience  of  each of the  directors  and  executive
officers of the Company is as follows:

      John B. Watts III is President  and Director of the Company.  He is also
President  and  Director of ILM I Lease  Corporation.  Mr.  Watts was a Senior
Vice  President of PWPI from June 1988 to August 1996.  Mr. Watts has had over
17 years of  experience  in  acquisitions,  dispositions  and  finance of real
estate.  He received  degrees of Bachelor  of  Architecture,  Bachelor of Arts
and Master of Business Administration from the University of Arkansas.

      Lawrence A. Cohen is a Director of the  Company.  Mr.  Cohen is also Vice
Chairman  and Chief  Financial  Officer  of Capital  Senior  Living  Corp.,  an
affiliate of Capital Senior  Management 2, Inc.,  which is the company that was
contracted by the Company in July 1996 to perform property  management services
for the Senior  Housing  Facilities.  Mr. Cohen joined  Capital  Senior  Living
Corp. in November  1996.  Mr. Cohen was President and Chief  Executive  Officer
of PWPI  until  August  1996.  Mr.  Cohen  is also a  member  of the  board  of
directors of ILM,  PaineWebber  Independent  Living Mortgage Fund, Inc. (ILM1),
ILM I Lease  Corporation and Retail Property  Investors,  Inc. (RPI). Mr. Cohen
received his LL.M (in Taxation) from New York University  School of Law and his
J.D.  degree from St. John's  University  School of Law. Mr. Cohen received his
B.B.A. degree in accounting from George Washington  University.  He is a member
of the New York Bar and is a Certified Public Accountant.

      Jeffry R.  Dwyer is a Director  of the  Company.  Mr.  Dwyer is a partner
with  the law firm of  Akin,  Gump,  Straus,  Hauer & Feld in the  District  of
Columbia,  which he joined in 1993. Prior to joining Akin, Gump, Straus,  Hauer
& Feld,  Mr. Dwyer was a partner with the law firm of Morrison & Foerster  from
1989 to 1993.  Immediately prior to joining Morrison & Foerster,  Mr. Dwyer was
a partner with the law firm of Lane & Edson.  Mr. Dwyer also  presently  serves
as a director of ILM, ILM1 and ILM I Lease  Corporation.  Mr. Dwyer has written
several books on real estate  financing  and taught Real Estate  Planning as an
Adjunct  Professor  at  the  Georgetown   University  Law  Center.   Mr.  Dwyer
graduated  from  Georgetown  University  and  received  his law degree from the
Georgetown University Law Center.

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

      David F. Brooks is Vice  President  and Secretary of the Company and First
Vice President and Assistant  Treasurer of PWPI which Mr. Brooks joined in March
1980.  From 1972 to 1980,  Mr.  Brooks was an  Assistant  Treasurer  of Property
Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant
Treasurer of Capital for Real Estate,  which  provided  real estate  investment,
asset management and consulting services.

      Timothy J. Medlock is Treasurer  of the Company and a Vice  President  and
Treasurer  of PWPI  which he  joined in 1986.  From 1986 to August of 1989,  Mr.
Medlock served as the Controller.  From 1983 to 1986, Mr. Medlock was associated
with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate  University in
1983 and received his Masters in Accounting from New York University in 1985.

      Valda M. Webster Kreie is Assistant  Secretary of the Company and a Vice
President  of  PWPI.  Ms.  Kreie  joined  PWPI in 1989  as an  Assistant  Vice
President.  From 1981 to 1987,  Ms. Kreie was the Contract and Title  Attorney
for Santa Fe  Minerals,  Inc. in Tulsa,  Oklahoma.  Ms. Kreie  graduated  from
Oklahoma  State  University  in 1978  and  received  her law  degree  from The
University of Tulsa College of Law in 1981.  Ms. Kreie is a licensed  attorney
in   Massachusetts   and  Oklahoma  and  a  licensed  real  estate  broker  in
Massachusetts.

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

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

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

Item 11.  Executive Compensation

     The  Company's  independent  directors are entitled to receive total annual
compensation  of $9,000 plus  reimbursement  for expenses  incurred in attending
meetings  and as a result of other  work  performed  for the  Company.  With the
exception of John B. Watts III  beginning  in August  1996,  the officers of the
Company  are also  officers  of PWPI and  receive  compensation  from PWPI which
indirectly  relates to  services to the  Company.  In  addition,  the Company is
required to pay certain fees to the Advisor as described in Item 13.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

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

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

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

Item 13.  Certain Relationships and  Related Transactions

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

      Under  the  Advisory  Agreement,   the  Advisor  has  specific  management
responsibilities;  to perform day-to-day operations of the Company and to act as
the investment advisor and consultant for the Company in connection with general
policy and  investment  decisions.  The Advisor  will receive a fee in an amount
equal to 0.5% of the gross  operating  revenue of the  facilities.  The  Advisor
earned management fees totalling $66,000 for the year ended August 31, 1996. The
Advisor and its affiliates are reimbursed for their direct expenses  relating to
the administration of the Company.

      An affiliate of the Advisor performs certain accounting,  tax preparation,
securities law compliance and investor communications and relations services for
the Company.  Total costs incurred by this affiliate in providing these services
are allocated among several entities, including the Company. Included in general
and administrative expenses on the accompanying statement of income for the year
ended August 31, 1996 is $55,000,  representing reimbursements to this affiliate
for providing such services to the Company.

      The Company  retained  Capital  Senior  Management 2, Inc.  ("Capital") of
Dallas,  Texas to be the manager of the senior housing facilities  pursuant to a
Management  Agreement  which  commenced  on July 29,  1996.  In  November  1996,
Lawrence A. Cohen,  a director of the  Company and  President,  Chief  Executive
Officer and Director of ILM, became Vice Chairman and Chief Financial Officer of
Capital's parent company.  As a result, the management  contract with Capital is
considered  a related  party  transaction.  Under  the  terms of the  Agreement,
Capital  will earn a Base  Management  Fee  equal to 4% of the  Gross  Operating
Revenues of the senior  housing  facilities,  as defined.  Capital  will also be
eligible to earn an Incentive Management Fee equal to 25% of the amount by which
the average monthly Net Cash Flow of the senior housing facilities,  as defined,
for the  twelve  month  period  ending  on the last day of each  calendar  month
exceeds a specified Base Amount.  Each August 31,  beginning on August 31, 1997,
the Base Amount will be increased  annually based on the percentage  increase in
the Consumer  Price  Index.  ILM has  guaranteed  the payment of all fees due to
Capital  under the  terms of the  Management  Agreement.  Capital  earned  total
management fees of $60,000 for August 1996 which is included in accounts payable
- affiliates on the accompanying balance sheet as of August 31, 1996.


<PAGE>






                                   PART IV



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

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

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

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

           (3)     Exhibits:

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

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

    (c)    Exhibits:

                   See (a)(3) above.

    (d)    Financial Statement Schedules:

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






<PAGE>


                                  SIGNATURES

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


                                         ILM II LEASE CORPORATION




                                          By: /s/ John B. Watts III
                                              -----------------------
                                             John B. Watts III
                                             President




                                          By: /s/ Timothy J. Medlock
                                             ------------------------
                                             Timothy J. Medlock
                                             Treasurer
                                             (functioning as chief financial
                                             and accounting officer)


Dated:  December 13, 1996

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



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



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



By:/s/ John B. Watts III                        Date:  December 13, 1996
   -------------------------------                     -----------------
   John B. Watts III
   Director

<PAGE>


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

                           ILM II LEASE CORPORATION


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

(3) and (4) Registration Statement on Form 10        Filed with the Commission
            of the Registrant dated July 20, 1995,   pursuant to Rule 424(c)
            as supplemented.                         and incorporated herein
                                                     by reference.


(10)        Contracts regarding retention of Capital Filed as Exhibits 1 and 2
            Senior Management 2, Inc. as property    to Current Report on 
            manager                                  Form 8-K date July 29, 
                                                     1996 and incorporated 
                                                     herein by reference.

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


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



<PAGE>


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

                           ILM II LEASE CORPORATION

       INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES


                                                                    Reference
                                                                    ---------

ILM I Lease Corporation:

   Report of independent auditors                                       F-2

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

   Statements of operations  for the year ended August 31, 1996 
     and the period September 12, 1994 (inception) to August 31, 1995   F-4

   Statements of changes in shareholders' equity for the year ended
     August 31, 1996 and the period September 12, 1994 (inception) 
     to August 31, 1995                                                 F-5

   Statements  of cash flows for the year ended  August 31,  1996 and 
     the period September 12, 1994 (inception) to August 31, 1995       F-6

   Notes to financial statements                                        F-7




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



<PAGE>


                        REPORT OF INDEPENDENT AUDITORS



The Shareholders of
ILM II Lease Corporation:

     We have audited the accompanying balance sheets of ILM II Lease Corporation
as of August  31,  1996 and 1995,  and the  related  statements  of  operations,
changes in  shareholders'  equity,  and cash flows for the year ended August 31,
1996 and the period  September 12, 1994  (inception)  to August 31, 1995.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

     We conducted  our audit in  accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audit provides 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 ILM II Lease Corporation at
August 31, 1996 and 1995,  and the results of its  operations and its cash flows
for the year ended August 31, 1996 and the period September 12, 1994 (inception)
to August 31, 1995 in conformity with generally accepted accounting principles.





                                                      /S/ ERNST & YOUNG LLP
                                                      ---------------------
                                                          ERNST & YOUNG LLP




Boston, Massachusetts
December 13, 1996


<PAGE>


                           ILM II LEASE CORPORATION

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

                                    ASSETS

                                                            1996        1995
                                                            ----        ----


Cash and cash equivalents                                $  1,591      $    -
Accounts receivable                                             5           -
Prepaid expenses and other assets                             118           -
                                                         --------      ------
      Total current assets                                  1,714           -

Furniture, fixtures and equipment                             197           -
Less:  accumulated depreciation                               (14)          -
                                                         --------      -------
                                                              183           -

Deferred tax asset, net                                        38           -
                                                         --------      ------
                                                         $  1,935      $    -
                                                         ========      ======


                     LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued expenses                    $    503      $    -
Real estate taxes payable                                     203           -
Accounts payable - affiliates                                 327           -
Security deposits                                              12           -
                                                         --------      ------
      Total current liabilities                             1,045           -

Deferred rent payable                                         131           -
                                                         --------      ------
      Total liabilities                                     1,176           -

Shareholders' equity:
  Common stock, $0.01 par value, 
   20,000,000 shares authorized,
   5,180,952 shares issued and outstanding
   (15,000 shares issued and outstanding in 1995)              52           -
  Additional paid-in capital                                  448           1
  Retained earnings (deficit)                                 259          (1)
                                                         --------      -------
      Total shareholders' equity                              759            -
                                                         --------      -------
                                                         $  1,935      $     -
                                                         ========      =======










                            See accompanying notes.



<PAGE>


                            ILM II LEASE CORPORATION

                            STATEMENTS OF OPERATIONS
                For the year ended August 31, 1996 and the period
                September 12, 1994 (inception) to August 31, 1995
                    (In thousands, except per share amounts)

                                            1996              1995
                                            ----              ----

Revenues:
  Rental and other income               $ 13,163            $    -
  Interest income                             38                 -
                                        --------            ------
                                          13,201                 -

Expenses:
  Master lease rent expense                4,004                 -
  Dietary salaries, wages and food 
     service expenses                      2,409                 -
  Administrative salaries, wages 
     and expenses                          1,061                 -
  Marketing salaries, wages and expenses     684                 -
  Utilities                                1,008                 -
  Repairs and maintenance                    597                 -
  Real estate taxes                          508                 -
  Property management fees                   720                 -
  Other property operating expenses        1,412                 -
  General and administrative                 285                 1
  Advisory fees                               66                 -
  Depreciation expense                        14                 -
                                        --------            ------
                                          12,768                 1
                                        --------            ------

Income (loss) before taxes                   433                (1)

Income tax expense (benefit):
  Current                                    211                 -
  Deferred                                   (38)                -
                                        -----------         ------
                                             173                 -
                                        ----------          ------

Net income (loss)                       $     260           $   (1)
                                        =========           ======


Net income (loss) per share of 
  common stock                              $0.05           $(0.07)
                                            =====           ======

The above net income (loss) per share of common stock is based upon the weighted
average number of shares  outstanding for the year ended August 31, 1996 and the
period  September 12, 1994 (inception) to August 31, 1995 (5,180,952 and 15,000,
respectively).








                            See accompanying notes.


<PAGE>


                            ILM II LEASE CORPORATION

                  STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
               For the year ended August 31, 1996 and the period
               September 12, 1994 (inception) to August 31, 1995
                    (In thousands, except per share amounts)


                                Common Stock     Additional  Retained
                               $.01 Par Value    Paid-in     Earnings
                               Shares   Amount   Capital     (Deficit)   Total
                               ------   ------   -------     ---------   -----

Balance at September 12, 1994       -   $   -     $   -      $    -      $  -

Issuance of common stock       15,000       -         1           -         1

Net loss                            -       -         -          (1)       (1)
                           ----------   -----    ------      ------      -----

Balance at August 31, 1995     15,000       -         1          (1)        -

Issuance of common stock    5,165,952      52       447           -       499

Net income                          -       -         -         260       260
                           ----------   -----    ------      ------      ----

Balance at August 31, 1996 5,180,952    $  52    $  448      $  259      $759
                           =========    =====    ======      ======      ====
























                            See accompanying notes.


<PAGE>


                            ILM II LEASE CORPORATION

                            STATEMENTS OF CASH FLOWS
                For the year ended August 31, 1996 and the period
               September 12, 1994 (inception) to August 31, 1995
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)

                                                             1996        1995
                                                             ----        ----
Cash flows from operating activities:
   Net income (loss)                                    $     260      $   (1)
   Adjustments to reconcile net income (loss) to
     net cash provided by (used in) operating activities
     Depreciation expense                                      14           -
     Changes in assets and liabilities:
      Accounts receivable                                      (5)          -
      Prepaid expenses and other assets                      (118)          -
      Deferred tax asset, net                                 (38)          -
      Accounts payable and accrued expenses                   503           -
      Accounts payable - affiliates                           327           -
      Real estate taxes payable                               203           -
      Security deposits                                        12           -
      Deferred rent payable                                   131           -
                                                        ---------      ------
         Total adjustments                                  1,029           -
                                                        ---------      ------
         Net cash provided by (used in) operating
           activities                                       1,289          (1)

Cash flows from investing activities:
   Additions to furniture, fixtures and equipment            (197)          -
                                                        ---------      ------
         Net cash used in investing activities               (197)          -

Cash flows from financing activities:
   Proceeds from issuance of common stock                     499           1
                                                        ---------      ------
         Net cash provided by financing activities            499           1
                                                        ---------      ------

Net increase in cash and cash equivalents                   1,591           -

Cash and cash equivalents, beginning of period                  -           -
                                                        ---------      ------

Cash and cash equivalents, end of period                $   1,591      $    -
                                                        =========      ======

Supplemental disclosure:

Cash paid during the period for income taxes            $    220       $    -
                                                        =========      ======











                           See accompanying notes.


<PAGE>


                           ILM II LEASE CORPORATION
                        Notes to Financial Statements


1.    Organization and Nature of Operations

      ILM II Lease Corporation ("the Company") was organized as a corporation on
   September  12, 1994 under the laws of the state of Virginia.  Through  August
   31, 1995, the Company had no significant  operations.  The Company was formed
   by  PaineWebber  Independent  Living  Mortgage  Inc.  II (ILM) to operate six
   rental housing projects for independent  senior citizens ("the Senior Housing
   Facilities")  under a master lease  arrangement.  ILM initially made mortgage
   loans to Angeles  Housing  Concepts,  Inc.  ("AHC") secured by the Facilities
   between July 1990 and July 1992. In March 1993, AHC defaulted under the terms
   of such mortgage loans and in connection with the settlement of such default,
   title to the Senior Housing  Facilities was  transferred,  effective April 1,
   1994, to certain majority-owned, indirect subsidiaries of ILM, subject to the
   mortgage loans.  Subsequently,  the indirect  subsidiaries of ILM were merged
   into  ILM II  Holding,  Inc.  ("ILM  Holding").  As part of the  fiscal  1994
   settlement  agreement with AHC, AHC was retained as the property  manager for
   all of the Senior  Housing  Facilities  pursuant to the terms of a management
   agreement  which was  assigned to the  Company as of  September  1, 1995.  As
   discussed further in Note 6, the management agreement with AHC was terminated
   in July 1996. ILM has elected to be taxed as a Real Estate  Investment  Trust
   ("REIT")  under the Internal  Revenue Code of 1986,  as amended ("the Code"),
   for each  taxable  year of  operations.  In order to maintain its status as a
   REIT,  75% of ILM's annual gross  income must be Qualified  Rental  Income as
   defined by the Code. The rent paid by the residents of the Facilities  likely
   would not be deemed to be Qualified  Rental  Income  because of the extent of
   services provided to residents. Consequently, the operation of the Facilities
   by ILM or its  subsidiaries  over an extended  period of time could adversely
   affect ILM's status as a REIT.  Therefore,  ILM formed the Company to operate
   the Senior Housing  Facilities,  and by means of a distribution,  transferred
   the ownership of the common stock of the Company to the holders of ILM common
   stock on September 1, 1995 (see Note 4). Because the Company,  which is taxed
   as a regular C corporation,  is no longer a subsidiary of ILM, it can receive
   service-related income without endangering the REIT status of ILM.

      The  Company's  sole  business  is the  operations  of the Senior  Housing
   Facilities.  The Company has initially  leased the Senior Housing  Facilities
   from ILM Holding,  a majority-owned  and consolidated  affiliate of ILM which
   currently  holds title to the  Facilities,  pursuant to a master  lease which
   commenced on September 1, 1995 and expires on December 31, 2000 (December 31,
   1999 with respect to the Santa  Barbara  Facility)  (see Note 5). The Company
   has  entered  into  a  property  management  agreement  with  Capital  Senior
   Management  2, Inc. of Dallas,  Texas  ("Capital")  to handle the  day-to-day
   operations of the Senior Housing  Facilities.  The  management  contract with
   Capital was executed in July 1996.  In November  1996,  Lawrence A. Cohen,  a
   director of the Company and President,  Chief Executive  Officer and Director
   of ILM,  became Vice Chairman and Chief  Financial  Officer of Capital Senior
   Living Corp., an affiliate of Capital.  As a result, the management  contract
   with Capital is considered a related party transaction (see Note 3).

2.    Use of Estimates and Summary of Significant Accounting Policies

      The  accompanying  financial  statements have been prepared on the accrual
   basis  of  accounting  in  accordance  with  generally  accepted   accounting
   principles  which require  management to make estimates and assumptions  that
   affect the reported  amounts of assets and  liabilities  and  disclosures  of
   contingent assets and liabilities as of August 31, 1996 and 1995 and revenues
   and expenses for the year ended August 31, 1996 and the period from September
   12, 1994 (date of inception) to August 31, 1995.  Actual results could differ
   from the estimates and assumptions used.

      Furniture,  fixtures  and  equipment  are  carried  at the  lower of cost,
   reduced by accumulated depreciation, or fair value in accordance with FAS No.
   121,  "Accounting for the Impairment of Long-Lived  Assets and for Long-Lived
   Assets  To  Be  Disposed   Of."   Depreciation   expense  is  provided  on  a
   straight-line basis using an estimated useful life of 3 years.

      Units at the Senior Housing  Facilities are generally  rented for terms of
   twelve  months or less.  The base rent charged  varies  depending on the unit
   size,  with added fees  collected for more than one occupant per unit and for
   assisted  living  services.  Included in the amount of base rent  charged are
   certain  meals,  housekeeping,  medical and social  services  provided to the
   residents of each Facility.

      The Company rents the Facilities from ILM Holding pursuant to a multi-year
   operating lease. Rent expense is recognized on a straight-line basis over the
   term of the lease agreement.  Deferred rent payable represents the difference
   between rent expense  recognized on a  straight-line  basis and cash paid for
   rent pursuant to the terms of the lease agreement.

      The Company's policy is to expense all advertising costs as incurred.

      The cash and cash equivalents,  receivables,  accounts payable and accrued
   liabilities  appearing on the accompanying balance sheets represent financial
   instruments for purposes of Statement of Financial  Accounting  Standards No.
   107,  "Disclosures  about Fair Value of Financial  Instruments." The carrying
   amount of these assets and  liabilities  approximates  their fair value as of
   August 31, 1996 due to the short-term maturities of these instruments.

      Income  tax  expense  is  provided  for  using the  liability  method as
   prescribed  by  Statement  of  Financial   Accounting  Standards  No.  109,
   "Accounting for Income Taxes."

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

3.    Related Party Transactions

      The Company has entered into an Advisory  Agreement with PaineWebber Lease
   Advisor,  L.P. ("the Advisor"),  a Virginia limited partnership  comprised of
   ILM Lease Advisor,  Inc. as the general  partner and  Properties  Associates,
   L.P. as the  limited  partner.  ILM Lease  Advisor,  Inc.  is a  wholly-owned
   subsidiary of PaineWebber Properties  Incorporated ("PWPI"). The sole general
   partner of Properties Associates,  L.P. is PAM, Inc., which is a wholly-owned
   subsidiary of PWPI. In addition,  the limited partners and holders of certain
   assignee  interests  of PA are or  have  been  officers  of  PWPI.  PWPI is a
   wholly-owned  subsidiary  of  PaineWebber  Incorporated  ("PWI"),  which is a
   subsidiary  of Paine  Webber  Group,  Inc.  ("PaineWebber").  Subject  to the
   supervision  of and  pursuant to the general  policies  set by the  Company's
   Board of Directors, assistance in the managing of the business of the Company
   is provided by the Advisor. Under the Advisory Agreement, the Company engages
   the  Advisor  and the  Advisor  agrees to use its best  efforts to manage the
   day-to-day   affairs   and   operations   of  the   Company  and  to  provide
   administrative  services and facilities appropriate for such management.  The
   specific  duties  of  the  Advisor  under  the  Advisory   Agreement  include
   recommending selections of providers of professional and specialized services
   and handling other managerial  functions with respect to the Facilities.  The
   Advisor is also obligated to provide office and clerical  facilities adequate
   for the  Company's  operations  and to provide,  or obtain others to provide,
   accounting,    custodial,   funds   collection   and   payment,   stockholder
   communications,  legal and other  services  necessary in connection  with the
   Company's  operations.  The Advisory  Agreement also obligates the Advisor to
   handle or arrange  for the  handling  of the  Company's  financial  and other
   records.

      Either party may terminate the Advisory  Agreement at any time on or after
   January 1, 1996 on 90 days notice, and the Company may terminate the Advisory
   Agreement for cause at any time. The Advisor receives a base fee in an amount
   equal to 0.5% of the Gross Operating  Revenues of the Facilities  operated by
   the Company as  compensation  for its services.  This fee amounted to $66,000
   for the year ended August 31, 1996. In addition,  an affiliate of the Advisor
   is entitled to  reimbursement  for  expenses  incurred in  providing  certain
   financial,  accounting  and investor  communication  services to the Company.
   Included in general and administrative expenses for the year ended August 31,
   1996 is $55,000, representing reimbursements to this affiliate of the Advisor
   for providing such services to the Company.  In performing its services under
   the  Advisory  Agreement,  the Advisor is required to pay certain  employment
   expenses of its  personnel,  certain  expenses of employees and agents of the
   Advisor and of directors,  officers and employees of the Company who are also
   employees of the Advisor or its  affiliates,  and certain of its overhead and
   miscellaneous   administrative   expenses  relating  to  performance  of  its
   functions  under the  Advisory  Agreement.  The  Company is  responsible  for
   reimbursing  out-of-pocket  expenses of directors,  officers and employees of
   the Company  incurred by them  exclusively in such capacity and for all other
   costs of its operations.

      ILM II Lease  Corporation has retained  Capital Senior  Management 2, Inc.
   ("Capital") of Dallas, Texas to be the property manager of the senior housing
   facilities  pursuant to a Management  Agreement  which  commenced on July 29,
   1996. As discussed in Note 1, a director of the Company became an officer and
   director of Capital Senior Living Corp., an affiliate of Capital,  subsequent
   to the  commencement  of  the  management  agreement.  Under  the  Management
   Agreement, Capital generally is required to perform all operational functions
   necessary  to  operate  the  Facilities  other  than  certain  administrative
   functions.  The functions  performed by Capital include periodic reporting to
   and  coordinating  with the  Company,  leasing  the  individual  units in the
   Facilities,   maintaining  bank  accounts,  maintaining  books  and  records,
   advertising  and marketing the  Facilities,  hiring and  supervising  on-site
   personnel,  and  performing  maintenance.  Under the terms of the  Agreement,
   Capital will earn a Base  Management  Fee equal to 4% of the Gross  Operating
   Revenues of the Senior Housing Facilities,  as defined.  Capital will also be
   eligible to earn an  Incentive  Management  Fee equal to 25% of the amount by
   which the average monthly Net Cash Flow of the Senior Housing Facilities,  as
   defined,  for the twelve month period ending on the last day of each calendar
   month exceeds a specified  Base Amount.  Each August 31,  beginning on August
   31, 1997, the Base Amount will be increased  annually based on the percentage
   increase in the Consumer Price Index. PaineWebber Independent Living Mortgage
   Fund,  Inc. has  guaranteed  the payment of all fees due to Capital under the
   terms of the Management  Agreement.  Capital earned total  management fees of
   $60,000 for August 1996 which is included in accounts payable - affiliates on
   the accompanying balance sheet as of August 31, 1996.

      Accounts payable - affiliates at August 31, 1996 also includes advances of
   $225,000  received  from ILM Holding,  primarily for the purchase of personal
   property to operate the Senior Housing Facilities.

4. Capital Stock

      Prior to September 1, 1995, the Company was a  wholly-owned  subsidiary of
   ILM. Pursuant to a Reorganization and Distribution Agreement, ILM capitalized
   the Company with  $500,000,  an amount  estimated to provide the Company with
   necessary working capital.  On September 1, 1995, Mavricc Management Systems,
   Inc., as the distribution  agent, caused to be issued on the stock records of
   the Company the distributed  Common Stock of the Company,  in  uncertificated
   form,  to the holders of record of ILM common  stock at the close of business
   on July 14, 1995. One share of the Company's Common Stock was distributed for
   each  outstanding  share  of ILM  Common  Stock.  No  certificates  or  scrip
   representing  fractional  shares of the Company's Common Stock were issued to
   holders of ILM common stock as part of the distribution. In lieu of receiving
   fractional  shares,  each holder of ILM common stock who would otherwise have
   been  entitled to receive a fractional  share of the  Company's  Common Stock
   received a cash  payment  equivalent  to $0.14 per share for such  fractional
   interest.

5. The Master Lease Agreement

      ILM Holding (the "Lessor") has leased the Senior Housing Facilities to the
   Company  (the  "Lessee")  pursuant  to a  master  lease  which  commenced  on
   September 1, 1995. Under the terms of the master lease, which has a scheduled
   expiration  date of December 31, 2000  (December 31, 1999 with respect to the
   Santa  Barbara  Facility),  the Lessor has the right to terminate  the master
   lease as to any Facility  sold as of the date of such sale.  The master lease
   is accounted for as an operating lease in the Company's financial statements.

      Descriptions  of the  properties  covered by the master lease  between the
   Company and ILM Holding are summarized as follows:

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

      The Palms                  Fort Myers, FL         204     October 1988
      Crown Villa                Omaha, NE              73      January 1992
      Overland Park Place        Overland Park, KS      137     June 1984
      Rio Las Palmas             Stockton, CA           162     June 1988
      The Villa at Riverwood     St. Louis County, MO   119     June 1985
      Villa Santa Barbara  (2)   Santa Barbara, CA      123     June 1979

           (1)Date initial construction was completed.

           (2)The  Company  operates  Villa  Santa  Barbara  under a  co-tenancy
              arrangement with an affiliated  company,  ILM I Lease Corporation.
              The  Company  has  entered  into  an  agreement  with  ILM I Lease
              Corporation  regarding such joint tenancy. ILM I Lease Corporation
              was formed for similar  purposes  as the Company by an  affiliated
              REIT,  PaineWebber  Independent  Living Mortgage Fund, Inc., whose
              indirect  subsidiary  owns a portion  of the Villa  Santa  Barbara
              property.  The  portion  of the  Facility  leased  by the  Company
              represents 75% of the total project.

      Terms of the Master Lease Agreement
      -----------------------------------

      During the term of the master  lease,  the  Company  is  obligated  to pay
   annual base rent ("Base  Rent") for the  Facilities.  For calendar year 1995,
   the  annual  Base  Rent was  $3,548,700  (prorated  according  to the date of
   commencement  of the master  lease),  allocated as follows:  $849,836 for the
   Florida Facility, $541,010 for the Nebraska Facility, $720,252 for the Kansas
   Facility,  $591,429 for the Stockton,  California Facility,  $423,933 for the
   Missouri  Facility and $422,240 for the Santa Barbara,  California  Facility.
   For calendar  year 1996 and  subsequent  years,  the annual Base Rent will be
   $4,035,600, allocated as follows: $966,439 for the Florida Facility, $615,240
   for the Nebraska Facility, $819,074 for the Kansas Facility, $672,576 for the
   Stockton,  California  Facility,  $482,098  for  the  Missouri  Facility  and
   $480,173 for the Santa Barbara,  California  Facility.  The master lease is a
   "triple-net"   lease  whereby  the  Lessee  pays  all   operating   expenses,
   governmental taxes and assessments,  utility charges and insurance  premiums,
   as well as the  costs of all  required  maintenance,  personal  property  and
   non-structural repairs in connection with the operation of the Senior Housing
   Facilities  ("Additional  Rent"). ILM Holding,  as the Lessor, is responsible
   for all major  capital  improvements  and  structural  repairs  to the Senior
   Housing  Facilities.  In  addition,  beginning  in  January  1997 and for the
   remainder  of the lease  term,  the  Company  will also be  obligated  to pay
   variable rent ("Variable Rent") for each Facility. Such Variable Rent will be
   payable  quarterly and will equal 40% of the excess, if any, of the aggregate
   total revenues for the Facilities, on an annualized basis, over $13,021,000.

      Under the master lease,  the Company's use of the Facilities is limited to
   use as a Senior Housing  Facility  unless the Lessor's  consent to some other
   use is obtained.  The Company has  responsibility  to obtain and maintain all
   licenses,  certificates and consents needed to use and operate each Facility,
   and to use and maintain each  Facility in compliance  with all local board of
   health and other  applicable  governmental  and  insurance  regulations.  The
   Facilities  located in  California,  Florida and Kansas are  licensed by such
   states to provide assisted living services.  Also,  various health and safety
   regulations and standards  which are enforced by state and local  authorities
   apply to the  operation of all of the  Facilities.  Violations of such health
   and safety standards could result in fines, penalties,  closure of a Facility
   or other sanctions.

6. Contingencies

      A  management  agreement  between ILM  Holding  and AHC which  covered the
   management of all six Senior  Housing  Facilities was assigned to the Company
   effective  September 1, 1995.  On July 29, 1996,  the Company and ILM Holding
   ("the Companies")  terminated the property management agreement with AHC. The
   management  agreement was  terminated  for cause pursuant to the terms of the
   contract.  Simultaneously  with the termination of the management  agreement,
   the Companies,  together with certain affiliated entities, filed suit against
   AHC in the United States District Court for the Eastern  District of Virginia
   for breach of contract,  breach of fiduciary duty and fraud.  The Company and
   ILM Holding  allege that AHC  willfully  performed  actions  specifically  in
   violation of the management agreement and that such actions caused damages to
   the  Companies.  Due to  the  termination  of the  agreement  for  cause,  no
   termination  fee was  paid  to  AHC.  Subsequent  to the  termination  of the
   management  agreement,  AHC filed for protection under Chapter 11 of the U.S.
   Bankruptcy  Code  in  its  domestic  state  of  California.  The  filing  was
   challenged by the Companies,  and the Bankruptcy  Court  dismissed AHC's case
   effective  October 15, 1996.  In November  1996,  AHC filed with the Virginia
   District  Court an Answer in  response  to the  litigation  initiated  by the
   Companies and a Counterclaim  against ILM Holding.  The Counterclaim  alleges
   that the  management  agreement  was  wrongfully  terminated  for  cause  and
   requests  damages  which  include the payment of the  termination  fee in the
   amount of $750,000,  payment of management fees pursuant to the contract from
   August 1, 1996 through October 15, 1996,  which is the earliest date that the
   management  agreement could have been terminated  without cause, and recovery
   of  attorney's  fees  and  expenses.   ILM  guaranteed  the  payment  of  the
   termination  fee at issue in  these  proceedings.  The  Companies  intend  to
   diligently prosecute the case and to vigorously defend the counterclaims made
   by AHC. The eventual outcome of this termination  dispute cannot presently be
   determined.  Accordingly,  no provision for any liability  which might result
   from the  outcome  of this  matter  has  been  recorded  in the  accompanying
   financial statements.

7. Federal Income Taxes

      The  Company is taxable as a regular C  corporation  and,  therefore,  its
   income is subject to tax at the federal and state levels. The Company reports
   on a  calendar  year  for  tax  purposes.  Income  taxes  at the  appropriate
   statutory  rates  have  been  provided  for  in  the  accompanying  financial
   statements.

      Deferred  income tax benefit  reflects  the net tax  effects of  temporary
   differences  between  the  carrying  amounts  of assets and  liabilities  for
   financial  reporting  purposes and the amounts used for income tax  purposes.
   The Company's  deferred tax assets and  liabilities as of August 31, 1996 are
   comprised of the following amounts (in thousands):

            Deferred tax asset - straight-line rent expense           $    53
            Deferred tax liability - tax over book amortization            15
                                                                      -------
                 Net deferred tax asset                               $    38
                                                                      =======

      The  components  of income tax  expense  (benefit)  for fiscal 1996 are as
   follows (in thousands):

            Current:
              Federal              $    179
              State                      32
                                   --------
                 Total current          211
                                   --------

            Deferred:
              Federal                   (32)
              State                      (6)
                                   --------
                 Total deferred         (38)
                                   --------
                                   $    173
                                   ========
<PAGE>
      The  reconciliation  of income tax  computed at U.S.  federal  statutory
   rates to income tax expense is as follows (in thousands):

            Tax at U.S. statutory rates      $   147          34%
            State income taxes, net
              of federal tax benefit              26           6%
                                             -------          ---
                                             $   173          40%
                                             =======          ===