<PAGE>

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                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, 1999
                                       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: 0-25878

                             ILM I LEASE CORPORATION
             (Exact name of registrant as specified in its charter)
       Virginia                                                  04-3248637
-----------------------                                      -------------------
(State of organization)                                       (I.R.S. Employer
                                                             Identification No.)

8180 Greensboro Drive, Suite 850, McLean, VA                          22102
--------------------------------------------------------------------------------
(Address of principal executive office)                             (Zip Code)

Registrant's telephone number, including area code:                888-257-3550
                                                                   ------------

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

                                                           Name of each exchange
Title of each class                                         on 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 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     No  X
    ---    ---

Shares of common stock outstanding as of August 31, 1999: 7,519,430. The
aggregate sales price of the shares sold was $700,000. 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 III, Part IV
dated July 20, 1995, as supplemented [33 Act
filing #33-27653]

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

<PAGE>

<TABLE>
<CAPTION>

                             ILM I LEASE CORPORATION

                                 1999 FORM 10-K

                                TABLE OF CONTENTS

Part I                                                                                            Page
------                                                                                            ----

<S>      <C>       <C>                                                                             <C>
Item     1         Business........................................................................I-1

Item     2         Properties............................................................. ........I-5

Item     3         Legal Proceedings...............................................................I-5

Item     4         Submission of Matters to a Vote of Security Holders.............................I-6


Part II
-------

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

Item     6         Selected Financial Data................................................. ......II-2

Item     7         Management's Discussion and Analysis of Financial Condition
                     and Results of Operations....................................................II-3

Item     8         Financial Statements and Supplementary Data....................................II-8

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


Part III
--------

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

Item     11        Executive Compensation........................................................III-3

Item     12        Security Ownership of Certain Beneficial Owners and Management................III-4

Item     13        Certain Relationships and Related Transactions................................III-4


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.....................................................F1-F16

</TABLE>

<PAGE>

                            ILM I LEASE CORPORATION

                                     PART I

ITEM 1. BUSINESS

     ILM I Lease Corporation (the "Company") was incorporated on September 12,
1994, under the laws of the State of Virginia by ILM Senior Living, Inc., a
Virginia finite-life corporation ("ILM I"), formerly PaineWebber Independent
Living Mortgage Fund, Inc., to operate eight rental housing projects that
provide independent living and assisted living services for senior citizens (the
"Senior Housing Facilities") under the terms of a facilities lease agreement
dated September 1, 1995 (the "Facilities Lease Agreement"), between the Company,
as lessee, and ILM Holding, Inc. ("ILM Holding"), as lessor, and a direct
subsidiary of ILM I. The Company's sole business is the operation of the Senior
Housing Facilities.

    ILM I contributed $700,000 to the Company in return for all of the issued
and outstanding shares of the Company's common stock. ILM I had originally made
mortgage loans secured by the Senior Housing Facilities to Angeles Housing
Concepts, Inc. ("AHC") between June 1989 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 I, subject to the mortgage loans. Subsequently, these
property-owning subsidiaries of ILM I were merged into ILM Holding. As part of
the fiscal 1994 settlement agreement with AHC (the "Settlement Agreement"), ILM
Holding retained AHC 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 I is a public
company subject to the reporting obligations of the Securities and Exchange
Commission.

      ILM I has elected to qualify and 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 I's annual gross income must be Qualified Rental Income as defined by
the Code. The rent paid by the residents of the Senior Housing 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 Senior
Housing Facilities by ILM I or its subsidiaries over an extended period of time
could adversely affect ILM I's status as a REIT. Therefore, ILM I 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 I common stock on September 1, 1995. Because the Company,
which is taxed as a so-called "C" corporation, is no longer a subsidiary of ILM
I, it can receive service-related income without endangering the REIT status of
ILM I.

       On September 1, 1995, after ILM I 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 I's common stock. One share of common
stock of the Company was issued for each full share of ILM I's common stock
held. No fractional shares were issued. Holders of ILM I's common stock were not
required to pay any cash or other consideration or to exchange their common
stock of ILM I for the common stock of the Company. Prior to the distribution of
the Company's stock, ILM I's shareholders received an information statement
fully describing the Company and the distribution of its capital stock.

    ILM Holding (the "Lessor"), a majority-owned subsidiary of ILM I, leases
the Senior Housing Facilities to the Company (the "Lessee"), pursuant to a
Facilities Lease Agreement. Such lease was extended on a month-to-month basis on
November 16, 1999 beyond its original expiration date of December 31, 1999. ILM
I has entered into an agreement and plan of merger with Capital Senior Living
Corporation and certain affiliates of Capital, and has agreed to cause ILM
Holding to cancel and terminate the Facilities Lease Agreement immediately prior
to the effective time of the merger. While there can be no assurance,
consummation of the merger is presently anticipated in the first quarter of
calendar year 2000. The lease is accounted for as an operating lease in the
Company's financial statements.


                                      I-1

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 1.  BUSINESS (CONTINUED)

     In July 1996, following the termination of the property management
agreement with AHC, and the Company entered into a property management agreement
(the "Management Agreement") with Capital Senior Management 2, Inc. ("Capital")
to handle the day-to-day operations of the Senior Housing Facilities. Lawrence
A. Cohen, who served through July 28, 1998 as a Director of the Company and
President, Chief Executive Officer and Director of ILM I, has also served in
various management capacities at Capital Senior Living Corporation, an affiliate
of Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer
and Acting Chief Financial Officer of Capital Senior Living Corporation. As a
result, the Management Agreement with Capital was considered a related party
transaction through July 28, 1998.

       Pursuant to the Facilities Lease Agreement, the Company pays annual base
rent for the use of the Senior Housing Facilities in the aggregate amount of
$6,364,800. The facilities 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. Also, any fixed assets of the Company at a Senior Housing Facility
would remain with the Senior Housing Facility at the termination of the lease.
The Company also pays variable rent, on a quarterly basis, for each Senior
Housing Facility in an amount equal to 40% of the excess of aggregate total
revenues for the Senior Housing Facilities, on an annualized basis, over
$16,996,000. For the fiscal years ended August 31, 1999 and 1998, variable rent
expense was $1,164,000 and $894,000, respectively.

       On February 7, 1999, ILM I entered into an agreement and plan of merger
with Capital Senior Living Corporation, the corporate parent of Capital, and
certain affiliates of Capital. Although there can be no assurance as to whether
the merger will be consummated or, if consummated, as to the timing thereof, the
Company's operations would not be expected to continue beyond the effective time
of the merger.

                                      I-2

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 1.  BUSINESS (CONTINUED)

     Descriptions of the properties covered by the Facilities Lease Agreement
between the Company and ILM Holding at August 31, 1999 are summarized as
follows:



<TABLE>
<CAPTION>
                                                                               Year         Rentable        Resident
Property Name and Location (1)                    Type of Property        Facility Built    Units (3)     Capacities (3)
------------------------------                    ----------------        --------------   ----------     --------------

<S>                                            <C>                              <C>            <C>           <C>

Independence Village of Winston-Salem          Senior Housing Facility          1989           159           162
Winston-Salem, NC

Independence Village of East Lansing           Senior Housing Facility          1989           161           162
East Lansing, MI

Independence Village of Raleigh                Senior Housing Facility          1991           164           205
Raleigh, NC

Independence Village of Peoria                 Senior Housing Facility          1990           166           183
Peoria, IL

Crowne Point Apartments                        Senior Housing Facility          1984           135           163
Omaha, NE

Sedgwick Plaza Apartments                      Senior Housing Facility          1984           150           170
Wichita, KS

West Shores                                    Senior Housing Facility          1986           136           166
Hot Springs, AR

Villa Santa Barbara (2)                        Senior Housing Facility          1979           125           125
Santa Barbara, CA

</TABLE>

(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 Company operates Villa Santa Barbara under a co-tenancy arrangement
     with an affiliated company, ILM II Lease Corporation ("Lease II"). The
     Company has entered into an agreement with Lease II regarding such joint
     tenancy. Lease II was formed for similar purposes as the Company by an
     affiliated company, ILM II Senior Living, Inc. ("ILM II"), a subsidiary of
     which owns a portion of the Villa Santa Barbara property. The portion of
     the Senior Housing Facility leased by the Company represents 25% of the
     total project. Villa Santa Barbara is 25% owned by ILM Holding and 75% by
     ILM II Holding, Inc., a direct subsidiary of ILM II, as tenants in common.
     Upon the sale of ILM I or ILM II, arrangements would be made to transfer
     the Santa Barbara facility to the non-selling joint tenant (or one of its
     subsidiaries). The property was extensively renovated in 1995.

(3)  Rentable units represent the number of apartment units and is a measure
     commonly used in the real estate industry. Resident capacity equals the
     number of bedrooms contained within the apartment units and corresponds to
     measures commonly used in the healthcare industry.

     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 Senior Housing Facilities. Therefore,
presentation of information about industry segments is not applicable.

                                      I-3

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 1.  BUSINESS (CONTINUED)

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

     Through June 18, 1997 and subject to the supervision of the Company's Board
of Directors, assistance in managing the business of the Company was provided by
PaineWebber Lease Advisor, L.P. ("PaineWebber"). For discussion purposes,
PaineWebber will refer to PaineWebber Lease Advisor, L.P. and all affiliates of
PaineWebber that provided services to the Company in the past. PaineWebber
resigned from this position effective as of June 18, 1997, although PaineWebber
agreed to perform certain administrative services for the Company and its
affiliates through August 31, 1997. Through the date of its resignation,
PaineWebber performed the day-to-day operations of the Company and acted as the
investment advisor and consultant for the Company. PaineWebber provided cash
management, accounting, tax preparation, financial reporting, investor
communications and relations as well as asset management services to the
Company. These services are now being provided to the Company, subject to the
supervision of the Company's Board of Directors, by various companies and
consultants including Greenberg Traurig, Fleet Bank, Ernst & Young LLP and
MAVRICC Management Systems, Inc.

     There are currently three Directors of the Company, none of whom are
affiliates of PaineWebber or the property management company. The Directors are
subject to removal by the vote of the holders of a majority of the outstanding
shares of the Company's common stock.

     The terms of transactions between the Company and PaineWebber and similar
disclosures with respect to relationships of other related parties which provide
services to the Company 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, on July 29, 1996, the Company terminated
the property management agreement with AHC and retained Capital to be the
property manager of the Senior Housing Facilities, and ILM I guaranteed the
payment of all fees due to Capital under the terms of the Management Agreement.
Lawrence A. Cohen, who served through July 28, 1998 as a Director of the Company
and President, Chief Executive Officer and Director of ILM I, has also served in
various management capacities at Capital Senior Living Corporation, an affiliate
of Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer
and Acting Chief Financial Officer of Capital Senior Living Corporation. As a
result, through July 28, 1998, Capital was considered a related party (see Item
13). For the years ended August 31, 1999 and 1998, Capital earned property
management fees from the Company of $1,008,000 and $919,000 respectively.

                                       I-4
<PAGE>

                            ILM I LEASE CORPORATION

ITEM 2.  PROPERTIES

     As of August 31, 1999, the Company has leased the eight operating
properties referred to under Item 1 above, to which reference is made for the
description, name and location of such properties.

     Average occupancy levels for each fiscal quarter during 1999, along with an
average for the year, are presented below for each property:

<TABLE>
<CAPTION>

                                                              Average Quarterly Occupancy
                                          --------------------------------------------------------------------
                                                                                                  Fiscal 1999
                                            11/30/98      2/28/99       5/31/99       8/31/99       Average
                                            --------      -------       -------       -------     -----------
<S>                                         <C>           <C>           <C>           <C>         <C>

Independence Village
   of Winston-Salem                           92%           94%           93%           96%           94%

Independence Village
   of East Lansing                            94%           89%           87%           87%           89%

Independence Village of Raleigh               95%           94%           95%           97%           95%

Independence Village of Peoria                98%           98%           96%           95%           97%

Crown Pointe Apartments                       98%           98%           96%           93%           96%

Sedgwick Plaza Apartments                     94%           91%           89%           87%           90%

West Shores                                   97%           94%           97%           97%           96%

Villa Santa Barbara                           97%           99%           97%           97%           98%

</TABLE>



ITEM 3.  LEGAL PROCEEDINGS

     On July 29, 1996, the Company and ILM Holding (collectively for this Item
3, the "Companies") terminated a property management agreement with AHC covering
the eight Senior Housing Facilities leased by the Company from ILM Holding. The
management agreement with AHC was terminated for "cause" pursuant to 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 Companies alleged, among
other things, 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 management 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 alleged that the management agreement was wrongfully
terminated for cause and requested damages which included the payment of the
termination fee in the amount of $1,250,000, payment of management fees pursuant
to the contract from August 1, 1996 through October 15, 1996, which is the
earliest date that the management agreement could have been terminated without
cause, and recovery of attorneys' fees and expenses.

                                      I-5

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 3.  LEGAL PROCEEDINGS (CONTINUED)

     The aggregate amount of damages against all parties as requested in AHC's
counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997, the court
issued orders to enter judgment against ILM I and ILM II in the amount of
$1,000,000. The orders did not contain any findings of fact or conclusions of
law. On July 10, 1997, the Company, ILM I, ILM II and Lease II filed a notice of
appeal to the United States Court of Appeals for the Fourth Circuit from the
orders.

     On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998 was a Director of the Company and President,
Chief Executive Officer and Director of ILM I, and others alleging that the
defendants intentionally interfered with AHC's property management agreement
(the "California litigation"). The complaint sought damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. At a Board meeting on
February 26, 1997, the Company's Board of Directors concluded that since all of
Mr. Cohen's actions relating to the California litigation were taken either on
behalf of the Company under the direction of the Board or as a PaineWebber
employee, the Company or its affiliates should indemnify Mr. Cohen with respect
to any expenses arising from the California litigation, subject to any insurance
recoveries for those expenses. Legal fees paid by the Company and Lease II on
behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board
also concluded that, subject to certain conditions, the Company or its
affiliates should pay reasonable legal fees and expenses incurred by Capital in
the California litigation. At August 31, 1999, the amount advanced to Capital by
the Company and Lease II for Capital's California litigation costs totaled
approximately $563,000.

     On August 18, 1998, the Company and its affiliates along with Capital and
its affiliates entered into a Settlement Agreement with AHC. The Company and
Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay
$625,000 to AHC in settlement of all claims including those related to the
Virginia litigation and the California litigation. The Company and its
affiliates also entered into an agreement with Capital and its affiliates to
mutually release each other from all claims that any such parties may have
against each other, other than any claims under the property management
agreements. On September 4, 1998, the full settlement amounts were paid to AHC
and its affiliates with the Company paying $975,000 and Lease II paying
$650,000.

     The Company has pending claims incurred in the normal course of business
which, in the opinion of the Company's Board of Directors, will not have a
material effect on the financial statements of the Company.

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

       None.

                                      I-6
<PAGE>

                            ILM I LEASE CORPORATION
                                     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 I. Pursuant to a reorganization and distribution agreement, ILM I
capitalized the Company with $700,000, 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 I 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 I common stock. No certificates or
scrip representing fractional shares of the Company's common stock were issued
to holders of ILM I common stock as part of the distribution. In lieu of
receiving fractional shares, each holder of ILM I 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 $0.15 per share for such
fractional interest. At August 31, 1999, there were 4,886 record holders of the
Company's shares. The shares do not trade on an established exchange and the
only market that has developed is a secondary market; therefore, little resale
activity occurs. Although PaineWebber and others may endeavor to assist
Shareholders desiring to sell their shares by attempting to match requests to
sell shares with requests to purchase shares, such transfers are not expected to
be frequent.

     The Company did not pay cash dividends in fiscal years 1999, 1998 and 1997
and may or may not determine to pay cash dividends in the future.

     On February 7, 1999, ILM I entered into an agreement and plan of merger
with Capital Senior Living Corporation, the corporate parent of Capital, and
certain affiliates of Capital. While there can be no assurance, consummation of
the merger is presently anticipated in the first quarter of calendar year 2000.
In connection with the merger, ILM I has agreed to cause ILM Holding to cancel
and terminate the Facilities Lease Agreement immediately prior to the effective
time of the merger. As noted above, the Facilities Lease Agreement was extended
on a month-to-month basis on November 16, 1999 beyond its original expiration
date of December 31, 1999. Although there can be no assurance as to whether the
merger will be consummated or, if consummated, as to the timing thereof, the
Company's operations would not be expected to continue beyond the effective time
of the merger.

                                      II-1
<PAGE>

                            ILM I LEASE CORPORATION

ITEM 6.  SELECTED FINANCIAL DATA

                            ILM I LEASE CORPORATION
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>

                                                                      For the year        For the year         For the year
                                                                           ended             ended                ended
                                                                    August 31, 1999     August 31, 1998      August 31, 1997
                                                                    ---------------     ---------------      ---------------

<S>                                                                    <C>              <C>                  <C>
Revenues                                                               $    19,923       $    19,294          $    18,121

Income (loss) before income taxes                                              393              (435)                (479)

Income tax expense (benefit)                                                   273               (54)                (192)
                                                                       -----------       -----------          -----------

Net income (loss)                                                      $       120       $      (381)        $      (287)
                                                                       ===========       ===========         ===========

Net income (loss) per share of common stock                            $      0.01       $     (0.05)        $     (0.04)
                                                                       ===========       ===========         ===========

Total assets                                                           $     1,895       $     3,198         $     2,633
                                                                       ===========       ===========         ===========

Shares outstanding                                                       7,519,430     7,519,430      7,519,430

</TABLE>

     The above selected financial data should be read in conjunction with the
financial statements and related notes appearing in item 14 of this annual
report.


                                      II-2
<PAGE>

                            ILM I LEASE CORPORATION

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

LIQUIDITY AND CAPITAL RESOURCES

     The Company was formed in 1995 by ILM I, a publicly-held, non-traded REIT,
for the purpose of operating eight Senior Housing Facilities under the terms of
a Facilities Lease Agreement. ILM I contributed $700,000 in return for all of
the issued and outstanding shares of the Company's common stock. ILM I had
originally made mortgage loans secured by the Senior Housing Facilities to AHC
between June 1989 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 I, subject to the mortgage
loans. Subsequently, these property-owning subsidiaries of ILM I were merged
into ILM Holding, which is also a majority-owned subsidiary of ILM I. As part of
the fiscal 1994 Settlement Agreement with AHC, ILM Holding retained AHC as the
property manager for all of the Senior Housing Facilities pursuant to the terms
of a management agreement 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 I has elected to qualify and 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 I's annual
gross income must be Qualified Rental Income as defined by the Code. The rent
paid by the residents of the Senior Housing 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 Senior Housing Facilities by
ILM I or its subsidiaries over an extended period of time could adversely affect
ILM I's status as a REIT. Therefore, ILM I 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 I common
stock. Because the Company, which is taxed as a so-called "C" corporation, is no
longer a subsidiary of ILM I, it can receive service-related income without
endangering the REIT status of ILM I.

     On September 1, 1995, after ILM I 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 I's common stock. One share of common
stock of the Company was issued for each full share of ILM I's common stock
held. No fractional shares were issued. Holders of ILM I's common stock were not
required to pay any cash or other consideration or to exchange their common
stock of ILM I for the common stock of the Company. Prior to the distribution of
the Company's stock, ILM I's shareholders received an information statement
fully describing the Company and the distribution of its capital stock.

     Pursuant to the Facilities Lease Agreement, the Company pays annual base
rent for the use of the Senior Housing Facilities in the aggregate amount of
$6,364,800. The facilities lease is a "triple-net" lease whereby the Company, as
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. Also, any fixed assets of the Company at a Senior
Housing Facility would remain with the Senior Housing Facility at the
termination of the lease. The Company also pays variable rent, on a quarterly
basis, for each Senior Housing Facility in an amount equal to 40% of the excess
of aggregate total revenues for the Senior Housing Facilities, on an annualized
basis, over $16,996,000. For the fiscal years ended August 31, 1999 and 1998,
variable rent expense was $1,164,000 and $894,000, respectively.

As noted above, the Company's Facilities Lease Agreement was extended on a
month-to-month basis on November 16, 1999 beyond its original expiration date of
December 31, 1999. 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 I, there is no assurance that the Company's
operations will continue beyond the term of the Facilities Lease Agreement.

                                     II-3

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

       On July 29, 1996, the Company terminated the management agreement with
AHC covering eight Senior Housing Facilities leased by the Company (see "Item 3,
Legal Proceedings") and retained Capital to be the manager of the Senior Housing
Facilities. ILM I has guaranteed the payment of all fees due to Capital under
the terms of the Management Agreement. Lawrence A. Cohen, who served through
July 28, 1998 as a Director of the Company and President, Chief Executive
Officer and Director of ILM I, has also served in various management capacities
at Capital Senior Living Corporation, an affiliate of Capital, since 1996. Mr.
Cohen currently serves as Chief Executive Officer and Acting Chief Financial
Officer of Capital Senior Living Corporation. As a result, the Management
Agreement with Capital was considered a related party transaction through July
28, 1998. Under the terms of the management agreement, Capital earns a base
management fee equal to 4% of the gross operating revenues of the Senior Housing
Facilities, as defined. Capital also earns an incentive management fee equal to
25% of the amount by which net cash flow of the Senior Housing Facilities, as
defined, exceeds a specified base amount. Each August 31, beginning on August
31, 1997, the base amount is increased based on the percentage increase in the
consumer price index as well as 15% of facility expansion costs.

       On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998 was a Director of the Company and President,
Chief Executive Officer and Director of ILM I, and others alleging that the
defendants intentionally interfered with AHC's property management agreement
(the "California litigation"). The complaint sought damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. At a Board meeting on
February 26, 1997, the Company's Board of Directors concluded that since all of
Mr. Cohen's actions relating to the California litigation were taken either on
behalf of the Company under the direction of the Board or as a PaineWebber
employee, the Company or its affiliates should indemnify Mr. Cohen with respect
to any expenses arising from the California litigation, subject to any insurance
recoveries for those expenses. Legal fees paid by the Company and Lease II on
behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board
also concluded that, subject to certain conditions, the Company or its
affiliates should pay reasonable legal fees and expenses incurred by Capital in
the California litigation. At August 31, 1999, the amount advanced to Capital by
the Company and Lease II for Capital's California litigation costs totaled
approximately $563,000.

       Occupancy levels for the eight properties which the Company leases from
ILM Holding averaged 94% and 96% for the fiscal years ended August 31, 1999 and
1998, respectively. The Senior Housing Facilities have generated sufficient net
cash flow to cover the base rent payments at their current level of $6,364,800
per year since the inception of the Company's operations. Base rent payments of
$6,364,800 will remain in effect throughout the remaining term of the lease. As
noted above, the Facilities Lease Agreement also provides for the payment of
variable rent beginning in January 1997. The Senior Housing Facilities are
currently generating gross revenues which are in excess of the specified
threshold in the variable rent calculation. Current annualized operating income
levels are sufficient to cover the Company's base and variable rent obligations
to ILM Holding. In fiscal years ended August 31, 1999 and 1998, the Company had
variable rent expense of $1,164,000 and $894,000, respectively.

        At August 31, 1999, the Company had cash and cash equivalents of
$1,066,000 compared to $1,897,000 at August 31, 1998. The decrease of $831,000
is primarily attributable to the September 4, 1998 payment of the AHC litigation
settlement of $975,000 (see Note 4) and increased investment in capital
improvements, offset by other cash flows provided by operating activities. As
noted above, under the terms of the Facilities Lease Agreement, the Lessor is
responsible for major capital improvements and 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

                                      II-4
<PAGE>

                            ILM I LEASE CORPORATION

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

in fiscal years 1999, 1998 and 1997. The Company 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 flows from the Senior Housing Facilities, net of the Facilities
Lease Agreement 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. Such
sources of liquidity are expected to be adequate to meet the Company's working
capital requirements on both a short-term and long-term basis.

YEAR 2000

     The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize the year 2000 as a date other than the year 2000. This could
result in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities.

     Based on ongoing assessments, the Company, through Capital, its property
manager, has developed a program to modify or replace portions of its software
and certain hardware, which are generally PC-based systems, so that those
systems will properly recognize and utilize dates beyond December 31, 1999.
While there can be no assurance, as of August 31, 1999, the Company believes
that it substantially completed all software and hardware upgrades. The Company
believes that these modifications and replacements of existing software and
certain hardware will mitigate the Year 2000 issue. However, if such
modifications and replacements are not completed timely, the Year 2000 issue
could have a material impact on the operations of the Company. The costs of Year
2000 remediation are not expected to be material based on the Company's
operations.

     The Company has assessed its exposure to operating equipment, and such
exposure is not significant due to the nature of the Company's business.

     The Company is not aware of any external agent with a Year 2000 issue that
would materially impact the Company's results of operations, liquidity or
capital resources. However, the Company has no means of determining whether or
ensuring those external agents will be Year 2000 ready. The inability of
external agents to complete their Year 2000 resolution process in a timely
fashion could impact the Company.

     Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company has
substantially completed all necessary phases of its Year 2000 program. In
addition, disruptions in the economy generally resulting from Year 2000 issues
could also adversely affect the Company. Although the amount of potential
liability and lost revenue cannot be reasonably estimated at this time, in a
worst case situation, if Capital, the Company's most significant third party
contractor, were to experience a year 2000 problem, it is likely that the
Company would not receive rental income as it became due from Senior Living
Facility residents. The Company in turn would fail to pay ILM Holding lease
payments as they arise under the master lease, and ILM Holding in turn would
fail to pay ILM I mortgage payments due it. However, the Company believes that
given the nature of its business, such problem would be temporary and is easily
remedied with a simple accounting.

                                      II-5
<PAGE>

                            ILM I LEASE CORPORATION

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

RESULTS OF OPERATIONS

1999 COMPARED TO 1998

     REVENUES. Total revenues were $19,923,000 for the year ended August 31,
1999 compared to $19,294,000 for the year ended August 31, 1998, representing an
increase of $629,000 or 3.3%. Rental and other income from the Company's senior
housing operations increased $675,000, or 3.5%, primarily as a result of
increases in rental rates at certain of the facilities located in strong
markets. Interest income decreased $46,000, or 74.2%, to $16,000 in fiscal year
1999, compared to $62,000 in fiscal year 1998, primarily due to a decrease in
cash and cash equivalents experienced throughout most of fiscal year 1999.

     EXPENSES. Total expenses were $19,530,000 in fiscal year 1999 compared to
$19,729,000 in fiscal year 1998 representing a decrease in expenses of $199,000
or 1.0%. Although overall expenses remained comparable, depreciation expense
increased $256,000, or 86.2%, due to recognition of changes in remaining useful
lives for certain assets purchased in 1999 and prior to conform to the lease
expiration date, as such assets are not subject to repurchase by ILM Holding.
Administrative salaries, wages and expenses increased $202,000, or 16.6%, while
general and administrative expenses decreased $42,000, or 15.9%. These increases
were offset, in part, by a decrease of $375,000 or 100% in termination fee
expense and a decrease of $850,000, or 75.7% in professional fees as a result of
reduced legal fees subsequent to the AHC litigation settlement. The increases in
other operating costs cited above were the result of higher operating levels
associated with improved occupancies.

     INCOME TAX EXPENSE. Income tax expense increased $327,000 or 605.6%, from
benefit of $54,000 in fiscal 1998 to expense of $273,000 in fiscal 1999, after
giving effect to the additional $115,000 increase in the valuation allowance in
1999 on the Company's deferred tax asset. The effective income tax rate was 69%
in fiscal 1999 and 7% in fiscal 1998.

     NET INCOME (LOSS). Primarily as a result of the factors discussed above,
net income increased $501,000 or 131.4% from a net loss of $381,000 in fiscal
1998 to net income of $120,000 in fiscal 1999.

1998 COMPARED TO 1997

     REVENUES. Total revenues were $19,294,000 for the year ended August 31,
1998 compared to $18,121,000 for the year ended August 31, 1997, representing an
increase of $1,173,000 or 6.5%. Rental and other income from the Company's
senior housing operations increased $1,183,000 primarily as a result of improved
occupancies and increases in rental rates at certain of the facilities located
in strong markets.

     EXPENSES. Total expenses were $19,729,000 in fiscal 1998 compared to
$18,600,000 in fiscal 1997, representing an increase of $1,129,000 or 6.1%. This
increase was principally comprised of increases in master lease expense of
$579,000, dietary and food service salaries, wages and expenses of $135,000,
general and administrative expenses of $593,000, property management fees of
$78,000, and additional termination fee expense incurred in fiscal 1998 of
$375,000 (see "Item 3, Legal Proceedings"). In addition, total charges to
depreciation expense in 1998 include additional depreciation expense of $136,000
in recognition of changes in remaining useful lives for certain assets purchased
in 1997 and prior to conform to the lease termination date, as such assets are
not subject to repurchase by ILM Holding. These increases were offset, in part,
by a decrease in administrative salaries, wages and expenses of $59,000,
marketing salaries, wages and expenses of $27,000, other property operating
expenses of $88,000 and advisory fees of $70,000. The increase in master lease
expense is the result of variable rents due under the Master Lease Agreement in
1998. General and administrative expense increased as a result of higher AHC
litigation expenses in 1998 coupled with the analysis of restructuring
alternatives performed by an independent investment banking firm. The increases
in other operating costs cited above were the result of higher operating levels
associated with improved occupancies.

                                      II-6

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

     INCOME TAX EXPENSE. Income tax benefit decreased from $192,000 in fiscal
1997 to a benefit of $54,000 in fiscal 1998, after giving effect to the $120,000
valuation allowance in 1998 on the Company's deferred tax asset. The effective
income tax rate was 7% in fiscal 1998 and 40% in fiscal 1997.

     NET INCOME (LOSS). Primarily as a result of the factors discussed above,
net loss increased from a net loss of $287,000 in fiscal 1997 to a net loss of
$381,000 in fiscal 1998.


INFLATION

     The Company completed its fourth full year of operations in fiscal 1999.
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
Facilities Lease Agreement between the Company and ILM Holding, 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 Senior Housing 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 ILM Holding.

                                    II-7

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

FORWARD-LOOKING INFORMATION

     CERTAIN STATEMENTS INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K ("ANNUAL
REPORT") CONSTITUTE "FORWARD-LOOKING STATEMENTS" INTENDED TO QUALIFY FOR THE
SAFE HARBORS FROM LIABILITY ESTABLISHED BY SECTION 27A OF THE SECURITIES ACT OF
1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES ACT
OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE FORWARD-LOOKING STATEMENTS
GENERALLY CAN BE IDENTIFIED AS SUCH BECAUSE THE CONTEXT OF THE STATEMENT WILL
INCLUDE WORDS SUCH AS "BELIEVES," "COULD," "MAY," "SHOULD," "ENABLE," "LIKELY,"
"PROSPECTS," "SEEK," "PREDICTS," "POSSIBLE," "FORECASTS," "PROJECTS,"
"ANTICIPATES," "EXPECTS" AND WORDS OF ANALOGOUS IMPORT AND CORRELATIVE
EXPRESSIONS THEREOF, AS WELL AS STATEMENTS PRECEDED OR OTHERWISE QUALIFIED BY:
"THERE CAN BE NO ASSURANCE" OR "NO ASSURANCE CAN BE GIVEN." SIMILARLY,
STATEMENTS THAT DESCRIBE THE COMPANY'S FUTURE PLANS, OBJECTIVES, STRATEGIES OR
GOALS ALSO ARE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS MAY ADDRESS FUTURE
EVENTS AND CONDITIONS CONCERNING, AMONG OTHER THINGS, THE COMPANY'S CASH FLOWS,
RESULTS OF OPERATIONS AND FINANCIAL CONDITION; THE CONSUMMATION OF ACQUISITION
AND FINANCING TRANSACTIONS AND THE EFFECT THEREOF ON THE COMPANY'S BUSINESS,
ANTICIPATED CAPITAL EXPENDITURES, PROPOSED OPERATING BUDGETS AND ACCOUNTING
RESERVES; LITIGATION; PROPERTY EXPANSION AND DEVELOPMENT PROGRAMS OR PLANS;
REGULATORY MATTERS; AND THE COMPANY'S PLANS, GOALS, STRATEGIES AND OBJECTIVES
FOR FUTURE OPERATIONS AND PERFORMANCE. ANY SUCH FORWARD-LOOKING STATEMENTS ARE
SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN SUCH FORWARD-LOOKING
STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO A NUMBER OF
ASSUMPTIONS REGARDING, AMONG OTHER THINGS, GENERAL ECONOMIC, COMPETITIVE AND
MARKET CONDITIONS. SUCH ASSUMPTIONS NECESSARILY ARE BASED ON FACTS AND
CONDITIONS AS THEY EXIST AT THE TIME SUCH STATEMENTS ARE MADE, THE PREDICTION OR
ASSESSMENT OF WHICH MAY BE DIFFICULT OR IMPOSSIBLE AND, IN ANY CASE, BEYOND THE
COMPANY'S CONTROL. FURTHER, THE COMPANY'S BUSINESS IS SUBJECT TO A NUMBER OF
RISKS THAT MAY AFFECT ANY SUCH FORWARD-LOOKING STATEMENTS AND ALSO COULD CAUSE
ACTUAL RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM THOSE PROJECTED OR
IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS ANNUAL REPORT ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE
CAUTIONARY STATEMENTS IN THIS PARAGRAPH. MOREOVER, THE COMPANY DOES NOT INTEND
TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN
GENERAL ECONOMIC, COMPETITIVE OR MARKET CONDITIONS AND DEVELOPMENTS BEYOND ITS
CONTROL.

     READERS OF THIS ANNUAL REPORT ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
ANY OF THE FORWARD-LOOKING STATEMENTS SET FORTH HEREIN AND THE COMPANY MAKES
ABSOLUTELY NO PROMISES, GUARANTEES, REPRESENTATIONS OR WARRANTIES AS TO THE
ACCURACY THEREOF.


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.

                                      II-8

<PAGE>

                             ILM I LEASE CORPORATION

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     There currently are three Directors of the Company. The Directors are
subject to removal by the vote of the holders of a majority of the outstanding
shares of the Company's common stock. 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 during fiscal 1999 are as follows:

<TABLE>
<CAPTION>

                                                                                         Dates
     Name                          Office                                      Age       of Office
     ----                          ------                                      ---       ---------
     <S>                           <C>                                         <C>       <C>

     Jeffry R. Dwyer               President, Secretary and Director           53        9/13/94*-present
     Julien G. Redele              Director                                    64        7/28/98-present
     J. William Sharman, Jr.       Director                                    59        9/18/97-present

</TABLE>

     * The date of incorporation of the Company.

     (c) There is no family relationship among any of the current Directors or
     Officers. All of the current Directors and Officers of the Company have
     been elected to serve until the Company's next annual meeting.

     (d) The business experience of each of the Directors and Executive Officers
     of the Company is as follows:


     JEFFRY R. DWYER is President, Secretary and Director of the Company. Mr.
Dwyer has served as President of the Company since March 9, 1999. Mr. Dwyer has
been a shareholder of Greenberg Traurig, which has provided legal services to
the Company and its affiliates since June 1997. From 1993 to 1997 Mr. Dwyer was
a partner with the law firm of Akin, Gump, Strauss, Hauer & Feld in the District
of Columbia. Prior to joining Akin, Gump, Strauss, Hauer & Feld, Mr. Dwyer was a
partner with the law firm of Morrison & Foerster from 1989 to 1993. Mr. Dwyer
also presently serves as Secretary and a Director of ILM I and ILM II and also
serves as President, Secretary and Director of Lease II. Mr. Dwyer has written
several law review articles and a major treatise 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.

     JULIEN G. REDELE is a Director and served as President of the Company from
July 28, 1998 through March 9, 1999. Mr. Redele' is one of the original founders
of SFRE, Inc., a Dutch owned real estate investment and development firm which
has served since 1963 as advisor to Dutch institutional, corporate and
individual investors active in the United States. Mr. Redele serves as a
Director of the Island Preservation Partnership. Mr. Redele attended
Westersingel Business School, Rotterdam, where he studied economics, law and
finance. Mr. Redele' also presently serves as Director of Lease II.

     J. WILLIAM SHARMAN, JR. is a Director and served as President of the
Company from September 18, 1997 through July 28, 1998. Mr. Sharman also
presently serves as a Director of Lease II. Mr. Sharman is the Chairman of the
Board and CEO of Lancaster Hotels and Resorts, Inc., a hotel management company.
Mr. Sharman served for ten years as Chairman of the Board and President of the
Lancaster Group, Inc., a real estate development firm based in Houston, Texas,
which is the predecessor of Lancaster Hotel Management, L.C. and Bayou Equities,
Inc. Mr. Sharman serves as a Director of Small Luxury Hotels, Ltd. of the United
Kingdom, an international hotel marketing and reservations firm, and also serves
on the Board of Trustees of St. Edwards University in Austin,

                                    III-1

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)



Texas. Mr. Sharman also presently serves as President and Director of ILM I and
ILM II. He has a Bachelor of Science degree from the University of Notre Dame.

          (e) Except for the Feldman litigation as discussed below, none of the
     current Directors and Officers were involved in legal proceedings which are
     material to an evaluation of his or her ability or integrity as a Director
     or Officer. On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees
     for the Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990
     commenced a purported class action on behalf of that trust and all other
     shareholders of ILM I and ILM II (affiliates of the Company, as previously
     described) in the Supreme Court of the State of New York, County of New
     York naming as defendants ILM I, ILM II and Lawrence A. Cohen, Jeffry R.
     Dwyer, Julien G. Redele, Carl J. Schramm and J. William Sharman, Jr. as the
     directors of both corporations. The class action complaint alleged that the
     directors engaged in wasteful and oppressive conduct and breached fiduciary
     duties in preventing the sale or liquidation of the assets of ILM I and ILM
     II, diverting certain of their assets. The complaint sought compensatory
     damages in an unspecified amount, punitive damages, the judicial
     dissolution of ILM I and ILM II, an order requiring the directors to take
     all steps to maximize Shareholder value, including either an auction or
     liquidation, and rescinding certain agreements, and attorney's fees. On
     July 8, 1998, the defendants moved to dismiss the complaint on all counts.

          On December 8, 1998, the Court granted the defendants' dismissal
     motion in part but afforded the plaintiffs leave to amend their complaint.
     In doing so, the Court accepted the defendants' position that all claims
     relating to the derivative actions were filed improperly. In addition, the
     Court dismissed common law claims for punitive damages, but allowed
     plaintiffs to amend their claims to assert claims alleging that the
     defendants injured shareholders without injuring ILM I and ILM II as a
     whole.

          On January 22, 1999, the Feldman plaintiffs filed an amended
     complaint, again purporting to commence a class action, and adding claims
     under Section 10(b) and 20(a) of the Securities and Exchange Act of 1934
     and Rule 10b-5 promulgated thereunder. Even before the defendants responded
     to that amended complaint, the Feldman plaintiffs moved for leave to file a
     second amended complaint to add claims directed at enjoining the announced
     potential merger of ILM I and ILM II with Capital Senior Living Corporation
     and, alternatively, for compensatory and punitive damages. At a hearing
     held on March 4, 1999 relating to the motion for leave to file that second
     amended complaint and to expedite discovery, the Court granted leave to
     amend and set a schedule for discovery leading to a trial (if necessary) in
     the summer of 1999.

          On March 9, 1999, the Feldman plaintiffs filed a second amended
     complaint, which included claims for injunctive relief and, in the
     alternative, damages in an unspecified amount. In response to the
     defendants' motion to dismiss the second amended complaint, on June 7, 1999
     the Court issued an order dismissing the plaintiffs' federal security
     claims but denying the motion to dismiss plaintiffs' claims for breach of
     fiduciary duty and judicial dissolution, which motion was addressed to the
     pleadings and not to the merits of the action.

          On June 21, 1999, the defendants answered the second amended complaint
     and denied any and all liability and moved for reconsideration of the
     portion of the Court's June 7, 1999 order denying their motion to dismiss.
     In response to discovery requests, ILM I, ILM II and others produced
     documents to the plaintiffs and depositions of current and former directors
     and others were taken. Discovery was completed as of July 1, 1999.

          On July 2, 1999, the parties to this action came to an
     agreement-in-principle to settle the action. On August 3, 1999, the parties
     entered into a Stipulation of Settlement and on August 11, 1999, the Court
     signed an order preliminarily approving the Stipulation and providing for
     notice of the Stipulation to the proposed settlement class.

                                     III-2

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)


               On September 30, 1999, the Court conducted a hearing and on
          October 4, 1999 issued an order certifying a settlement class and
          approving the proposed settlement as fair, reasonable and adequate,
          subject to the condition that certain modifications be made to the
          Stipulation of Settlement and any related documents filed with the
          Court on or before October 15, 1999.

               On October 15, 1999, the parties entered into a revised
          Stipulation of Settlement and filed it with the Court, which approved
          the settlement, by order dated October 21, 1999. In issuing that order
          the Court entered a final judgement dismissing the action and all
          non-derivative claims of the settlement class against the defendants
          with prejudice. In its October 4th order, the Court also denied the
          application by plaintiffs' counsel for payment of attorneys' fees and
          expenses, without prejudice to renewal within 14 days upon
          reapplication therefor. On or about October 14, 1999, plaintiffs'
          counsel reapplied to the Court for fees and expenses. A hearing was
          held November 5, 1999, in which the Court granted the application for
          attorneys' fees in the amount of $950,000 and costs in the amount of
          $182,000. Under the Stipulation, if the proposed merger is
          consummated, Capital Senior Living Corporation is responsible for
          payment of such attorneys' fees and expenses sought under this
          application, and if the proposed merger with Capital Senior Living
          Corporation is not consummated and if ILM I and ILM II enter into a
          transaction having similar effect to the merger with a third party,
          then ILM I and ILM II are responsible for such fees and expenses.

               (f) 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, 1999, there was
compliance with all filing requirements applicable to its Officers and Directors
and ten-percent beneficial holders.

ITEM 11.  EXECUTIVE COMPENSATION

          The Company's Directors each receive annual compensation of $12,000
plus $500 for attending each Board of Directors meeting and reimbursement for
expenses incurred in attending meetings and as a result of other work performed
for the Company. Officers of the Company are not compensated. Jeffry R. Dwyer
receives compensation from and is a shareholder of Greenberg Traurig, which acts
as Counsel to the Company and its affiliates. The former officers of the Company
who were also officers of PaineWebber received compensation from PaineWebber
which indirectly related to services to the Company because the Company was
required to pay certain fees to PaineWebber as described in Item 13. When
PaineWebber resigned as advisor to the Company, the former officers resigned
effective the same date; therefore no services were provided by such persons
subsequent to June 18, 1997. Lawrence A. Cohen, who was a Director of the
Company until July 28, 1998, received compensation from and was an employee of
Capital Senior Living Corporation, an affiliate of Capital and a related party
through July 28, 1998.

                                     III-3

<PAGE>

                            ILM I LEASE CORPORATION

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
          Company to own beneficially more than five percent of the outstanding
          shares of common stock of the Company.

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

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          Subject to the supervision of the Company's Board of Directors,
assistance in managing the business of the Company was provided by PaineWebber.
Under the advisory agreement, PaineWebber had 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. PaineWebber received a fee in an amount equal
to 0.5% of the gross operating revenue of the facilities. For the years ended
August 31, 1999, 1998 and 1997, PaineWebber earned management fees totaling $0,
$0 and $70,000, respectively. PaineWebber was reimbursed for direct expenses
relating to the administration of the Company. Paine Webber performed certain
accounting, tax preparation, securities law compliance and investor
communication and relations services for the Company. Included in general and
administrative expenses on the accompanying statements of income for the years
ended August 31, 1998, 1997 and 1996, is $0, $0 and $80,000, respectively,
representing reimbursements to PaineWebber for providing such services to the
Company. As discussed in Items 1 and 7, the Company, ILM I, ILM II and their
affiliates accepted the resignation of Paine Webber effective as of June 18,
1997. The Company, ILM I, ILM II and their affiliates and Paine Webber entered
into a transition services agreement pursuant to which PaineWebber would
continue to provide certain administrative services to the Company, ILM I, ILM
II and their affiliates through August 31, 1997.

          The advisory relationship with PaineWebber ceased on June 18, 1997;
therefore the payment of advisory fees ceased as of that date. Other services,
such as accounting, compliance, investor communications and relations, and cash
management services ceased on August 31, 1997; therefore, the Company was not
obligated to pay service fees past August 31, 1997 to PaineWebber.

                                     III-4

<PAGE>

                            ILM I LEASE CORPORATION

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)

          The Company retained Capital 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, Lawrence A. Cohen, who served through July 28,
1998 as a Director of the Company and President, Chief Executive Officer and
Director of ILM I, has also served in various management capacities at Capital
Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen
currently serves as Chief Executive Officer of Capital Senior Living
Corporation. Under the Management Agreement, Capital generally is required to
perform all operational functions necessary to operate the Senior Housing
Facilities other than certain administrative functions. The functions performed
by Capital include periodic reporting to and coordination with the Company,
leasing the individual units in the Senior Housing Facilities, maintaining bank
accounts, maintaining books and records, advertising and marketing the Senior
Housing Facilities, hiring and supervising on-site personnel, and performing
maintenance. Under the terms of the Management Agreement, Capital earns a base
management fee equal to 4% of the gross operating revenues of the Senior Housing
Facilities, as defined. Capital also earns an incentive management fee equal to
25% of the amount by which the net cash flow of the Senior Housing Facilities,
as defined, exceeds a specified base amount. Each August 31, beginning on August
31, 1997, the base amount is increased based on the percentage increase in the
Consumer Price Index as well as 15% of Facility expansion costs. ILM I has
guaranteed the payment of all fees due to Capital under the terms of the
Management Agreement. For the years ended August 31, 1999 and 1998, Capital
earned property management fees from the Company of $1,008,000 and $919,000,
respectively.

          On February 4, 1997, AHC filed a complaint in the Superior Court of
the State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998 was a Director of the Company and President,
Chief Executive Officer and Director of ILM I, and others alleging that the
defendants intentionally interfered with AHC's property management agreement
(the "California litigation"). The complaint sought damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. At a Board meeting on
February 26, 1997, the Company's Board of Directors concluded that since all of
Mr. Cohen's actions relating to the California litigation were taken either on
behalf of the Company under the direction of the Board or as a PaineWebber
employee, the Company or its affiliates should indemnify Mr. Cohen with respect
to any expenses arising from the California litigation, subject to any insurance
recoveries for those expenses. Legal fees paid by the Company and Lease II on
behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board
also concluded that, subject to certain conditions, the Company or its
affiliates should pay reasonable legal fees and expenses incurred by Capital in
the California litigation. At August 31, 1999, the amount advanced to Capital by
the Company and Lease II for Capital's California litigation costs totaled
approximately $563,000.

          On September 18, 1997, the Company entered into an agreement with
Capital Senior Development, Inc., an affiliate of Capital, to manage the
development process for the potential expansion of several of the Senior Housing
Facilities. Capital Senior Development, Inc. will receive a fee equal to 7% of
the total development costs of these expansions if they are pursued. ILM Holding
will reimburse the Company for all costs related to these potential expansions
including fees to Capital Senior Development, Inc. For the years ended August
31, 1999 and 1998, Capital Senior Development, Inc. earned fees from the Company
of $41,000 and $212,000, respectively, for managing pre-construction development
activities for potential expansions of the Senior Housing Facilities.

          Jeffry R. Dwyer, President, Secretary and Director of the Company, is
a shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig
earned fees from the Company of $64,000 and $168,000, respectively.

                                     III-5

<PAGE>

                            ILM I LEASE CORPORATION

                                     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)  Exhibits:

                           See (a)(3) above.

         (c)  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.


                                      IV-1
<PAGE>

                            ILM I LEASE CORPORATION

                                   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 I LEASE CORPORATION




                                    By: /s/ Jeffry R. Dwyer
                                        ----------------------------------------
                                        Jeffry R. Dwyer
                                        President
                                        (Principal Accounting Officer)


Dated: November 23, 1999
       -----------------

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/ Jeffry R. Dwyer                     Date: November 23, 1999
     ---------------------------------       -----------------------------------
     Jeffry R. Dwyer
     Director




By:  /s/ Julien G. Redele                    Date: November 22, 1999
     ---------------------------------       -----------------------------------
     Julien G. Redele
     Director




By:  /s/ J. William Sharman, Jr.             Date: November 23, 1999
     ---------------------------------       -----------------------------------
     J. William Sharman, Jr.
     Director


                                      IV-2

<PAGE>

                            ILM I LEASE CORPORATION

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

                             ILM I LEASE CORPORATION


                                INDEX TO EXHIBITS


<TABLE>
<CAPTION>
                                                                               PAGE NUMBER IN THE REPORT
EXHIBIT NO.                  DESCRIPTION OF DOCUMENT                            OR OTHER REFERENCE
-------------------------    -----------------------------------------          -------------------------
<S>                          <C>                                                <C>
(3) and (4)                  Registration Statement on Form 10 of               Filed with the Commission pursuant
                             the Registrant dated July 20, 1995, as             to Rule 424(c) and incorporated
                             supplemented.                                      herein by reference.

(13)                         Annual Reports to Shareholders                     No Annual Report for the year ended
                                                                                August 31, 1999 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.
</TABLE>

                                      IV-3

<PAGE>

                            ILM I LEASE CORPORATION

                           ANNUAL REPORT ON FORM 10-K
                         ITEM 14(a)(1) AND (2) AND 14(d)

                             ILM I LEASE CORPORATION


<TABLE>
<CAPTION>

         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES


                                                                                                           Reference
                                                                                                           ---------

ILM I LEASE CORPORATION:

<S>      <C>                                                                                               <C>

         Report of Ernst & Young LLP, Independent Auditors                                                    F-2

         Balance Sheets as of August 31, 1999 and 1998                                                        F-3

         Statements of Operations for the years ended August 31, 1999, 1998 and 1997                          F-4

         Statements of Changes in Shareholders' Equity for the years ended August 31, 1999, 1998
           and 1997                                                                                           F-5

         Statements of Cash Flows for the years ended August 31, 1999, 1998 and 1997                          F-6

         Notes to Financial Statements                                                                        F-7

</TABLE>


         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.


                                      F-1

<PAGE>


                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


The Shareholders of
ILM I Lease Corporation:

          We have audited the accompanying balance sheets of ILM I Lease
Corporation as of August 31, 1999 and 1998, and the related statements of
operations, changes in shareholders' equity, and cash flows for each of the
three years in the period ended August 31, 1999. 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 audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

          In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of ILM I Lease
Corporation at August 31, 1999 and 1998, and the results of its operations and
its cash flows for each of the three years in the period ended August 31, 1999,
in conformity with generally accepted accounting principles.



                                                               ERNST & YOUNG LLP


Dallas, Texas
October  22, 1999
except for Note 1, as to which the date is
November 16, 1999


                                      F-2
<PAGE>

                            ILM I LEASE CORPORATION


                                 BALANCE SHEETS
                            August 31, 1999 and 1998
                  (Dollars in thousands, except per share data)

                                     ASSETS


<TABLE>
<CAPTION>
                                                                    1999           1998
                                                                ----------     ----------


<S>                                                               <C>        <C>
Cash and cash equivalents                                            $ 1,066       $ 1,897
Accounts receivable, net                                                 102            56
Tax refunds receivable                                                     1           145
Prepaid expenses and other assets                                        278           127
                                                                     -------       -------
         Total current assets                                          1,447         2,225

Furniture, fixtures and equipment                                      1,299           999
Less: accumulated depreciation                                          (943)         (390)
                                                                     -------       -------
                                                                         356           609

Deferred tax asset, net                                                   92           364
                                                                     -------       -------
                                                                     $ 1,895       $ 3,198
                                                                     -------       -------
                                                                     -------       -------

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued expenses                                $   868       $ 1,123
Termination fee payable                                                   --           975
Real estate taxes payable                                                190           213
Accounts payable - related party                                         305           438
Security deposits                                                          7             7
                                                                     -------       -------
         Total current liabilities                                     1,370         2,756

Deferred rent payable                                                     12            49
                                                                     -------       -------
         Total liabilities                                             1,382         2,805

Commitments and contingencies

Shareholders' equity:
   Common stock, $0.01 par value, 20,000,000 shares authorized,
     7,519,430 shares issued and outstanding                              75            75
   Additional paid-in capital                                            625           625
   Accumulated deficit                                                  (187)         (307)
                                                                     -------       -------
         Total shareholders' equity                                      513           393
                                                                     -------       -------
                                                                     $ 1,895       $ 3,198
                                                                     =======       =======
</TABLE>

                             See accompanying notes.

                                      F-3

<PAGE>

                            ILM I LEASE CORPORATION

                            STATEMENTS OF OPERATIONS
               For the years ended August 31, 1999, 1998 and 1997
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>


                                                                                        1999            1998           1997
                                                                                    ------------   ------------   ------------

REVENUES:
<S>                                                                                   <C>            <C>            <C>
   Rental and other income                                                            $ 19,907       $ 19,232       $ 18,049
   Interest income                                                                          16             62             72
                                                                                      --------       --------       --------
                                                                                        19,923         19,294         18,121

EXPENSES:
   Facilities lease rent expense                                                         7,492          7,222          6,643
   Dietary and food service salaries, wages and expenses                                 3,664          3,566          3,431
   Administrative salaries, wages and expenses                                           1,420          1,218          1,277
   Marketing salaries, wages and expenses                                                  931            856            883
   Utilities                                                                               839            834            850
   Repairs and maintenance                                                                 732            661            666
   Real estate taxes                                                                       836            827            816
   Property management fees                                                              1,008            919            841
   Other property operating expenses                                                     1,507          1,486          1,574
   General and administrative                                                              222            264             66
   Directors compensation                                                                   52             81             31
   Professional fees                                                                       273          1,123            778
   Termination fee expense                                                                  --            375            600
   Advisory fees                                                                            --             --             70
   Depreciation expense                                                                    553            297             74
                                                                                      --------       --------       --------
                                                                                        19,530         19,729         18,600
                                                                                      --------       --------       --------

Income (loss) before income taxes                                                          393           (435)          (479)

Income tax expense (benefit):
   Current                                                                                  --             --             92
   Deferred                                                                                273            (54)          (284)
                                                                                      --------       --------       --------
                                                                                           273            (54)          (192)
                                                                                      --------       --------       --------

NET INCOME (LOSS)                                                                     $    120       $   (381)      $   (287)
                                                                                      --------       --------       --------
                                                                                      --------       --------       --------

NET INCOME (LOSS) PER SHARE OF COMMON STOCK                                           $   0.01       $  (0.05)      $  (0.04)
                                                                                      --------       --------       --------
                                                                                      --------       --------       --------
The above net income (loss) per share of common stock is based upon the weighted
average number of shares outstanding for the years ended August 31, 1999, 1998
and 1997 of 7,519,430.

</TABLE>


                             See accompanying notes.

                                       F-4


<PAGE>

                            ILM I LEASE CORPORATION

                  STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
               For the years ended August 31, 1999, 1998 and 1997
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>

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

<S>                              <C>              <C>             <C>            <C>               <C>
BALANCE AT AUGUST 31, 1996       7,519,430        $      75        $     625      $      361        $    1,061


Net loss                                --               --               --            (287)             (287)
                                ----------       ----------       ----------      -----------       ----------


BALANCE AT AUGUST 31, 1997       7,519,430               75              625              74               774


Net loss                                --               --               --            (381)             (381)
                                ----------       ----------       ----------       ----------       ----------


BALANCE AT AUGUST 31, 1998       7,519,430               75              625            (307)              393


Net income                              --               --               --             120               120
                                ----------       ----------       ----------       ----------       ----------


BALANCE AT AUGUST 31, 1999       7,519,430       $       75       $      625       $    (187)       $      513
                                ----------       ----------       ----------       ----------       ----------
                                ----------       ----------       ----------       ----------       ----------

</TABLE>

                             See accompanying notes.

                                      F-5

<PAGE>

                            ILM I LEASE CORPORATION

                            STATEMENTS OF CASH FLOWS
               For the years ended August 31, 1999, 1998 and 1997
                                 (In thousands)

<TABLE>
<CAPTION>

                                                                      1999          1998          1997
                                                                   -----------   -----------   -----------
<S>                                                                 <C>           <C>           <C>
Cash flows from operating activities:
   Net income (loss)                                                $   120       $  (381)      $  (287)
   Adjustments to reconcile net income (loss) to
     net cash (used in) provided by operating activities:
       Depreciation expense                                             553           297            74
       Deferred tax benefit,  net                                       272           (54)         (284)
       Changes in assets and liabilities:
         Accounts receivable - related party                             --            93            --
         Accounts receivable, net                                       (46)          (56)           77
         Tax refund receivable                                          144          (145)           --
         Prepaid expenses and other assets                             (151)          132             8
         Accounts payable and accrued expenses                         (255)          241            19
         Accounts payable - related party                              (133)          322          (422)
         Termination fee payable                                       (975)          375           600
         Real estate taxes payable                                      (23)           43          (130)
         Security deposits                                               --             2            --
         Deferred rent payable                                          (37)          (37)          (37)
                                                                    -------       -------       -------
           Net cash (used in) provided by operating activities         (531)          832          (382)
                                                                    -------       -------       -------

Cash flows from investing activities:
   Additions to furniture, fixtures and equipment                      (300)         (408)         (330)
                                                                    -------       -------       -------
           Net cash used in investing activities                       (300)         (408)         (330)
                                                                    -------       -------       -------

Net (decrease) increase in cash and cash equivalents                   (831)          424          (712)

Cash and cash equivalents, beginning of period                        1,897         1,473         2,185
                                                                    -------       -------       -------

Cash and cash equivalents, end of period
                                                                    $ 1,066       $ 1,897       $ 1,473
                                                                    -------       -------       -------
                                                                    -------       -------       -------

SUPPLEMENTAL DISCLOSURE:

Cash paid during the period for income taxes                        $   126       $   201       $   181
                                                                    -------       -------       -------
                                                                    -------       -------       -------

</TABLE>

                             See accompanying notes.


                                       F-6

<PAGE>

                            ILM I LEASE CORPORATION
                          Notes to Financial Statements

1.   ORGANIZATION, RESTRUCTURING, AND NATURE OF OPERATIONS

          ILM I 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 ILM Senior Living, Inc. ("ILM I"), formerly PaineWebber
     Independent Mortgage Fund, Inc., to operate eight rental housing projects
     that provide independent living and assisted living services for
     independent senior citizens ("the Senior Housing Facilities") under a
     Facilities Lease Agreement. ILM I initially made mortgage loans to Angeles
     Housing Concepts, Inc. ("AHC") secured by the Senior Housing Facilities
     between June 1989 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 I,
     subject to the mortgage loans. Subsequently, the indirect subsidiaries of
     ILM I were merged into ILM 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 I has elected to qualify and 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 I's annual gross income must be Qualified
     Rental Income as defined by the Code. The rent paid by the residents of the
     Senior Housing 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 Senior Housing Facilities by ILM I or
     its subsidiaries over an extended period of time could adversely affect ILM
     I's status as a REIT. Therefore, ILM I 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 I common
     stock on September 1, 1995 (see Note 4). Because the Company, which is
     taxed as a so-called "C" corporation, is no longer a subsidiary of ILM I,
     it can receive service-related income without endangering the REIT status
     of ILM I.

         The Company's sole business is the operations of the Senior Housing
     Facilities. The Company leases the Senior Housing Facilities from ILM
     Holding, which is now a subsidiary of ILM I that holds title to the Senior
     Housing Facilities, pursuant to a Facilities Lease Agreement. Such lease
     was extended on a month-to-month basis on November 16, 1999 beyond its
     original expiration date of December 31, 1999. ILM I has entered into an
     agreement and plan of merger with Capital Senior Living Corporation and
     certain affiliates of Capital, and has agreed to cause ILM Holding to
     cancel and terminate the Facilities Lease Agreement immediately prior to
     the effective time of the merger. While there can be no assurance,
     consummation of the merger is presently anticipated in the first quarter of
     calendar year 2000. The lease is accounted for as an operating lease in the
     Company's financial statements.

         In July 1996, following the termination of the property management
     agreement with AHC, the Company entered into a property management
     agreement (the "Management Agreement") with Capital Senior Management 2,
     Inc. ("Capital") to handle the day-to-day operations of the Senior Housing
     Facilities. Lawrence A. Cohen, who served through July 28, 1998 as a
     Director of the Company and President, Chief Executive Officer and Director
     of ILM I, has also served in various management capacities at Capital
     Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen
     currently serves as Chief Executive Officer and Acting Chief Financial
     Officer of Capital Senior Living Corporation. As a result, the Management
     Agreement with Capital was considered a related party transaction through
     July 28, 1998 (see Note 3.).

            On February 7, 1999, ILM I entered into an agreement and plan of
     merger with Capital Senior Living Corporation, the corporate parent of
     Capital, and certain affiliates of Capital. Although there can be no
     assurance as to whether the merger will be consummated or, if consummated,
     as to the timing thereof, the Company's operations would not be expected to
     continue beyond the effective time of the merger.


                                      F-7
<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

2.   USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

          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, 1999 and
     1998 and revenues and expenses for the years ended August 31, 1999, 1998
     and 1997. Actual results could differ from the estimates and assumptions
     used. Certain amounts reported in 1998 have been reclassified to conform to
     the 1999 presentation.

          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 was provided on
     a straight-line basis using an estimated useful life of 3 to 5 years. In
     1998, the Company changed the estimated useful lives of its assets the
     lease termination date of December 31, 1999, as such assets are not subject
     to repurchase by ILM Holding. For the fiscal year ended August 31, 1998,
     this increased depreciation expense by $136,000.

          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 Senior Housing Facility.

          The Company rents the Senior Housing 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.
     For the years ended August 31, 1999, 1998 and 1997, advertising expenses
     were $931,000, $856,000 and $883,000, respectively.

          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, 1999 due to the short-term nature 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." The Company has provided a valuation
     allowance to recognize the effect that the lease termination date may have
     on the estimated net realizable value of the deferred tax asset as
     explained more fully in Note 7 to the accompanying financial statements. At
     August 31, 1999 and 1998, a valuation allowance for deferred taxes of
     $235,000 and $120,000, respectively, is included in deferred taxes, net, on
     the accompanying balance sheet.

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

                                      F-8

<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)


3.   RELATED PARTY TRANSACTIONS

          The Company entered into an advisory agreement (the "Advisory
     Agreement") with PaineWebber Lease Advisor, L.P. For discussion purposes,
     PaineWebber Lease Advisor, L.P. and all affiliates of PaineWebber will be
     collectively referred to as PaineWebber ("PaineWebber"). PaineWebber served
     in this capacity through June 18, 1997. 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 was provided by
     PaineWebber. Under the Advisory Agreement, the Company engaged PaineWebber
     and PaineWebber agreed 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 PaineWebber under the Advisory Agreement included recommending
     selections of providers of professional and specialized services and
     handling other managerial functions with respect to the Senior Housing
     Facilities. PaineWebber was 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
     obligated PaineWebber to handle or arrange for the handling of the
     Company's financial and other records.

          PaineWebber received a base fee in an amount equal to 0.5% of the
     gross operating revenues of the Senior Housing Facilities operated by the
     Company as compensation for its services. For the years ended August 31,
     1999, 1998 and 1997, this fee amounted to $0, $0 and $70,000, respectively.
     In addition, PaineWebber was 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, 1998, 1997 and 1996
     was $0, $0 and $80,000, respectively, representing reimbursements to
     PaineWebber for providing such services to the Company. In performing its
     services under the Advisory Agreement, PaineWebber was required to pay
     certain employment expenses of its personnel, certain expenses of employees
     and agents of PaineWebber and of Directors, officers and employees of the
     Company who are also employees of PaineWebber, and certain of its overhead
     and miscellaneous administrative expenses relating to performance of its
     functions under the Advisory Agreement. The Company was 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.

           The Company retained Capital 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, Lawrence A. Cohen, who served
     through July 28, 1998 as a Director of the Company and President, Chief
     Executive Officer and Director of ILM I, has also served in various
     management capacities at Capital Senior Living Corporation, an affiliate of
     Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer
     of Capital Senior Living Corporation. Under the Management Agreement,
     Capital generally is required to perform all operational functions
     necessary to operate the Senior Housing Facilities other than certain
     administrative functions. The functions performed by Capital include
     periodic reporting to and coordination with the Company, leasing the
     individual units in the Senior Housing Facilities, maintaining bank
     accounts, maintaining books and records, advertising and marketing the
     Senior Housing Facilities, hiring and supervising on-site personnel, and
     performing maintenance. Under the terms of the Management Agreement,
     Capital earns a base management fee equal to 4% of the gross operating
     revenues of the Senior Housing Facilities, as defined. Capital also earns
     an incentive management fee equal to 25% of the amount by which the net
     cash flow of the Senior Housing Facilities, as defined, exceeds a specified
     base amount. Each August 31, beginning on August 31, 1997, the base amount
     is increased based on the percentage increase in the Consumer Price Index
     as well as 15% of Facility expansion costs. ILM I has guaranteed the
     payment of all fees due to the terms of the Management Agreement. For the
     years ended August 31, 1999 and 1998, Capital earned property
     management fees from the Company of $1,008,000 and $919,000,  respectively.


                                      F-9

<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

3.   RELATED PARTY TRANSACTIONS (CONTINUED)

           On February 4, 1997, AHC filed a complaint in the Superior Court of
     the State of California against Capital, the new property manager; Lawrence
     A. Cohen, who, through July 28, 1998 was a Director of the Company and
     President, Chief Executive Officer and Director of ILM I, and others
     alleging that the defendants intentionally interfered with AHC's property
     management agreement (the "California litigation"). The complaint sought
     damages of at least $2,000,000. On March 4, 1997, the defendants removed
     the case to Federal District Court in the Central District of California.
     At a Board meeting on February 26, 1997, the Company's Board of Directors
     concluded that since all of Mr. Cohen's actions relating to the California
     litigation were taken either on behalf of the Company under the direction
     of the Board or as a PaineWebber employee, the Company or its affiliates
     should indemnify Mr. Cohen with respect to any expenses arising from the
     California litigation, subject to any insurance recoveries for those
     expenses. Legal fees paid by the Company and Lease II on behalf of Mr.
     Cohen totaled $229,000 as of August 31, 1999. The Company's Board also
     concluded that, subject to certain conditions, the Company or its
     affiliates should pay reasonable legal fees and expenses incurred by
     Capital in the California litigation. At August 31, 1999, the amount
     advanced to Capital by the Company and Lease II for Capital's California
     litigation costs totaled approximately $563,000.

         On September 18, 1997, the Company entered into an agreement with
     Capital Senior Development, Inc., an affiliate of Capital, to manage the
     development process for the potential expansion of several of the Senior
     Housing Facilities. Capital Senior Development, Inc. will receive a fee
     equal to 7% of the total development costs of these expansions if they are
     pursued. ILM Holding will reimburse the Company for all costs related to
     these potential expansions including fees to Capital Senior Development,
     Inc. For the years ended August 31, 1999 and 1998, Capital Senior
     Development, Inc. earned fees from the Company of $41,000 and $212,000,
     respectively, for managing pre-construction development activities for
     potential expansions of the Senior Housing Facilities.

         Jeffry R. Dwyer, President, Secretary and Director of the Company, is a
     shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
     since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig
     earned fees from the Company of $64,000 and $168,000, respectively.

          Accounts payable - related party at August 31, 1999 and 1998 includes
     variable rent payable to ILM Holding of $305,000 and $243,000,
     respectively, and expense reimbursements payable to Lease II in the amounts
     of $0 and $102,000, respectively.

4.   CAPITAL STOCK

          Prior to September 1, 1995, the Company was a wholly-owned subsidiary
     of ILM I. Pursuant to a reorganization and distribution agreement, ILM I
     capitalized the Company with $700,000, 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 I 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 I Common
     Stock. No certificates or scrip representing fractional shares of the
     Company's Common Stock were issued to holders of ILM I Common Stock as part
     of the distribution. In lieu of receiving fractional shares, each holder of
     ILM I 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 $0.15 per share for such fractional interest.

                                      F-10

<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

5.   THE FACILITIES LEASE AGREEMENT

         ILM Holding (the "Lessor"), a majority-owned subsidiary of ILM I,
     leases the Senior Housing Facilities to the Company (the "Lessee"),
     pursuant to a Facilities Lease Agreement. Such lease was extended on a
     month-to-month basis on November 16, 1999 beyond its original expiration
     date of December 31, 1999. ILM I has entered into an agreement and plan of
     merger with Capital Senior Living Corporation and certain affiliates of
     Capital, and has agreed to cause ILM Holding to cancel and terminate the
     Facilities Lease Agreement immediately prior to the effective time of the
     merger. While there can be no assurance, consummation of the merger is
     presently anticipated in the first quarter of calendar year 2000. The lease
     is accounted for as an operating lease in the Company's financial
     statements.

         Descriptions of the properties covered by the Facilities Lease
     Agreement between the Company and ILM Holding are summarized as follows:

<TABLE>
<CAPTION>

                                                                Year
                                                              Facility    Rentable     Resident
     Name                              Location                 Built    Units (2)   Capacity (2)
     ----                              --------                 -----    ---------   ------------

<S>                                    <C>                      <C>         <C>           <C>
     Independence Village of           East Lansing, MI         1989        161           162
     East Lansing

     Independence Village of           Winston-Salem, NC        1989        159           161
     Winston-Salem

     Independence Village of           Raleigh, NC              1991        164           205
     Raleigh

     Independence Village of           Peoria, IL               1990        165           181
     Peoria

     Crown Pointe Apartments           Omaha, NE                1984        135           163

     Sedgwick Plaza Apartments         Wichita, KS              1984        150           170

     West Shores                       Hot Springs, AR          1986        136           166

     Villa Santa Barbara (1)           Santa Barbara, CA        1979        125           125

</TABLE>


(1)      The Company operates Villa Santa Barbara under a co-tenancy arrangement
         with an affiliated company, ILM II Lease Corporation ("Lease II"). The
         Company has entered into an agreement with Lease II regarding such
         joint tenancy. Lease II was formed for similar purposes as the Company
         by an affiliated company, ILM II Senior Living, Inc. ("ILM II"), a
         subsidiary of which owns a portion of the Villa Santa Barbara property.
         The portion of the Senior Housing Facility leased by the Company
         represents 25% of the total project. Villa Santa Barbara is 25% owned
         by ILM Holding and 75% by ILM II Holding, Inc., a direct subsidiary of
         ILM II, as tenants in common. Upon the sale of ILM I or ILM II,
         arrangements would be made to transfer the Santa Barbara facility to
         the non-selling joint tenant (or one of its subsidiaries). The property
         was extensively renovated in 1995.

(2)      Rentable units represent the number of apartment units and is a measure
         commonly used in the real estate industry. Resident capacity equals the
         number of bedrooms contained within the apartment units and corresponds
         to measures commonly used in the healthcare industry.

                                      F-11

<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

5.   THE FACILITIES LEASE AGREEMENT (CONTINUED)

           Pursuant to the Facilities Lease Agreement, the Company pays annual
     base rent for the use of the Senior Housing Facilities in the aggregate
     amount of $6,364,800. The facilities 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. Also, any fixed
     assets of the Company at a Senior Housing Facility would remain with the
     Senior Housing Facility at the termination of the lease. The Company also
     pays variable rent, on a quarterly basis, for each Senior Housing Facility
     in an amount equal to 40% of the excess of aggregate total revenues for the
     Senior Housing Facilities, on an annualized basis, over $16,996,000. For
     the fiscal years ended August 31, 1999 and 1998, variable rent expense was
     $1,164,000 and $894,000, respectively.

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

6.   LEGAL PROCEEDINGS AND CONTINGENCIES

         A management agreement between ILM Holding and AHC which covered the
     management of all eight Senior Housing Facilities was assigned to the
     Company effective September 1, 1995. On July 29, 1996, Lease I and ILM
     Holding (collectively for this Item 3, the "Companies") terminated a
     property management agreement with AHC covering the eight Senior Housing
     Facilities leased by Lease I from ILM Holding. The management agreement
     with AHC was terminated for "cause" pursuant to 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
     Companies alleged, among other things, 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 management 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 alleged
     that the management agreement was wrongfully terminated for cause and
     requested damages which included the payment of the termination fee in the
     amount of $1,250,000, payment of management fees pursuant to the contract
     from August 1, 1996 through October 15, 1996, which is the earliest date
     that the management agreement could have been terminated without cause, and
     recovery of attorneys' fees and expenses.

                                      F-12


<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

6.    LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)

         The aggregate amount of damages against all parties as requested in
     AHC's counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997,
     the court issued orders to enter judgment against ILM I and ILM II in the
     amount of $1,000,000. The orders do not contain any findings of fact or
     conclusions of law. On July 10, 1997, the Company, ILM I, ILM II and
     Lease II filed a notice of appeal to the United States Court of Appeals
     for the Fourth Circuit from the orders.

         On February 4, 1997, AHC filed a complaint in the Superior Court of the
     State of California against Capital, the new property manager; Lawrence A.
     Cohen, who, through July 28, 1998 was a Director of the Company and
     President, Chief Executive Officer and Director of ILM I, and others
     alleging that the defendants intentionally interfered with AHC's property
     management agreement (the "California litigation"). The complaint sought
     damages of at least $2,000,000. On March 4, 1997, the defendants removed
     the case to Federal District Court in the Central District of California.
     At a Board meeting on February 26, 1997, the Company's Board of Directors
     concluded that since all of Mr. Cohen's actions relating to the California
     litigation were taken either on behalf of the Company under the direction
     of the Board or as a PaineWebber employee, the Company or its affiliates
     should indemnify Mr. Cohen with respect to any expenses arising from the
     California litigation, subject to any insurance recoveries for those
     expenses. Legal fees paid by the Company and Lease II on behalf of Mr.
     Cohen totaled $229,000 as of August 31, 1999. The Company's Board also
     concluded that, subject to certain conditions, the Company or its
     affiliates should pay reasonable legal fees and expenses incurred by
     Capital in the California litigation. At August 31, 1999, the amount
     advanced to Capital by the Company and Lease II for Capital's California
     litigation costs totaled approximately $563,000.

         On August 18, 1998, the Company and its affiliates along with Capital
     and its affiliates entered into a Settlement Agreement with AHC. The
     Company and Lease II agreed to pay $1,625,000 and Capital and its
     affiliates agreed to pay $625,000 to AHC in settlement of all claims
     including those related to the Virginia litigation and the California
     litigation. The Company and its affiliates also entered into an agreement
     with Capital and its affiliates to mutually release each other from all
     claims that any such parties may have against each other, other than any
     claims under the property management agreements. On September 4, 1998, the
     full settlement amounts were paid to AHC and its affiliates with the
     Company paying $975,000 and Lease II paying $650,000.

         The Company has pending claims incurred in the normal course of
     business which, in the opinion of the Company's management, will not have a
     material effect on the financial statements of the Company.

                                      F-13

<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

7.   FEDERAL INCOME TAXES

          The Company is taxable as a so-called `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, 1999 and
     1998, are comprised of the following amounts (in thousands):

<TABLE>
<CAPTION>

                                                                                     1999     1998
                                                                                    ------   -------

<S>                                                                                 <C>       <C>
             Deferred tax asset - straight-line rent expense                        $   5     $ 19
             Deferred tax asset - book over tax  depreciation                         236       54
             Deferred tax asset - book over tax amortization                           23       45
             Net operating loss carryforward                                           63      366
                                                                                    -----    -----
             Gross deferred tax asset                                                 327      484
             Valuation allowance for deferred tax asset                              (235)    (120)
                                                                                     -----    -----
               Net deferred tax asset                                               $  92     $364
                                                                                     -----    -----
                                                                                     -----    -----

</TABLE>

          The Company has provided a valuation allowance to consider the effects
     that the lease termination date might have on historical taxable income and
     the fact that cumulative tax over book depreciation might not be
     recoverable against future taxable income if and when the lease is
     terminated. The net operating loss carryforward will expire in 2013.


          The  components  of income tax  expense  (benefit)  for  fiscal  1999,
     1998 and 1997 are as  follows  (in thousands):

<TABLE>
<CAPTION>
                                                                   1999        1998        1997
                                                                   ----        ----        ----
<S>                                                                <C>         <C>         <C>
             Current:
               Federal                                             $ --        $ --        $ 78
               State                                                 --          --          14
                                                                  -----      ------       -----
                      Total current                                  --          --          92
                                                                  -----      ------       -----
             Deferred:
               Federal                                              238         (47)       (241)
               State                                                 35          (7)        (43)
                                                                  -----      ------       -----
                      Total deferred                                273         (54)       (284)
                                                                  -----      ------       -----
                                                                  $ 273      $  (54)      $(192)
                                                                  =====      ======       =====

</TABLE>
                                      F-14

<PAGE>

                            ILM I LEASE CORPORATION
                    Notes to Financial Statements (continued)

7.       FEDERAL INCOME TAXES (CONTINUED)

         The reconciliation of income tax computed for fiscal 1999, 1998 and
     1997, at U.S. federal statutory rates to income tax expense (benefit) is as
     follows (in thousands):

<TABLE>
<CAPTION>
                                                  1999                    1998                     1997
                                             ----------------      --------------------     --------------------
         <S>                                 <C>       <C>         <C>          <C>         <C>          <C>
             Tax at U.S. statutory rates       $ 134     34%         $(148)       (34%)       $(163)       (34%)
             State income taxes, net
               of federal tax benefit             24      6%           (26)         (6)         (29)         (6)
             Valuation allowance                 115     29%           120          33           --          --
                                               -----    -----        ------       -----       ------       -----
                                               $ 273    (69%)         $(54)        (7%)       $(192)       (40%)
                                               -----    -----        ------       -----       ------       -----
                                               -----    -----        ------       -----       ------       -----
</TABLE>


                                      F-15