UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C.  20549
                      ----------------------------------


                                   FORM 10-Q


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

                  For the quarterly period ended May 31, 1997

                                      OR

            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

            For the transition period from  ______   to  ______ .


                            Commission File Number:  0-25880


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


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



265 Franklin Street, Boston, MA                                   02110
-------------------------------                                   --------
(Address of principal executive offices)                          (Zip Code)

Registrant's telephone number, including area code (800) 225-1174
                                                   --------------

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

Shares  on  common  stock  outstanding  as of May  31,  1997:  5,180,952.  The
aggregate  sales price of the shares sold was $500,000.  This does not reflect
market value.  There is no current market for these shares.

<PAGE>

                           ILM II LEASE CORPORATION

                                BALANCE SHEETS
                 May 31, 1997 and August 31, 1996 (Unaudited)
                                (In thousands)

                                    ASSETS

                                                          May 31     August 31
                                                          ------     ---------

Cash and cash equivalents                               $   1,532    $  1,591
Accounts receivable                                           327           5
Prepaid expenses and other assets                              94         118
                                                        ---------    --------
      Total current assets                                  1,953       1,714

Furniture, fixtures and equipment                             360         197
Less:  accumulated depreciation                               (44)        (14)
                                                        ---------    --------
                                                              316         183

Deferred tax asset, net                                        17          38
                                                        ---------    --------
                                                        $   2,286    $  1,935
                                                        =========    ========


                     LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued expenses                   $     650    $    528
Real estate taxes payable                                     121         203
Accounts payable - affiliates                                 366         302
Security deposits                                              13          12
                                                        ---------    --------
      Total current liabilities                             1,150       1,045

Deferred rent payable                                         108         131
                                                        ---------    --------
      Total liabilities                                     1,258       1,176

Shareholders' equity                                        1,028         759
                                                        ---------    --------
                                                        $   2,286    $  1,935
                                                        =========    ========
















                            See accompanying notes.


<PAGE>


                            ILM II LEASE CORPORATION

                              STATEMENTS OF INCOME
      For the three and nine months ended May 31, 1997 and 1996 (Unaudited)
                    (In thousands, except per share amounts)

                                   Three Months Ended      Nine Months Ended
                                          May 31,                May 31,
                                   ------------------      -----------------
                                     1997       1996        1997        1996
                                     ----       ----        ----        ----

Revenues:
  Rental and other income         $ 3,587    $  3,304    $ 10,745    $  9,702
  Interest income                       9          10          28          24
                                  -------    --------    --------    ---------
                                    3,596       3,314      10,773       9,726

Expenses:
  Master lease rent expense         1,131       1,001       3,264       3,003
  Dietary salaries, wages and
   food service expenses              662         586       1,977       1,739
  Administrative salaries, wages
    and expenses                      297         238         877         767
  Marketing salaries, wages 
    and expenses                      161         170         456         503
  Utilities                           240         239         763         722
  Repairs and maintenance             127         136         371         395
  Real estate taxes                   129         143         383         391
  Property management fees            169         181         549         534
  Other property operating expenses   354         355       1,140       1,046
  General and administrative          297          33         461          73
  Advisory fees                        18          16          54          48
  Depreciation expense                 12           -          30           -
                                  -------    --------    --------    --------
                                    3,597       3,098      10,325       9,221
                                  -------    --------    --------    --------

Income (loss) before taxes             (1)        216         448         505

Income tax expense (benefit):
  Current                               -          79         158         246
  Deferred                              -           7          21         (44)
                                  -------    --------    --------    --------
                                        -          86         179         202
                                  -------    --------    --------    --------

Net income (loss)                 $   (1)    $   130     $    269    $    303
                                  ======     =======     ========    ========


Earnings (loss) per share
  of common stock                 $(0.00)      $0.02       $0.05       $0.06
                                  ======       =====       =====       =====


The above earnings  (loss) per share of common stock is based upon the 5,180,952
shares outstanding for each period.









                            See accompanying notes.


<PAGE>


                            ILM II LEASE CORPORATION

                  STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
           For the nine months ended May 31, 1997 and 1996 (Unaudited)
                                 (In thousands)


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

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

Issuance of common stock    5,166       52        447          -           499

Net income                      -        -          -        303           303
                           ------    -----     ------     ------        ------

Balance at May 31, 1996    5,181     $  52     $  448     $  302        $  802
                           =====     =====     ======     ======        ======

Balance at August 31, 1996 5,181     $  52     $  448     $  259        $  759

Net income                     -         -          -        269           269
                           -----     -----     ------     ------        ------

Balance at May 31, 1997    5,181     $  52     $  448     $  528        $1,028
                           =====     =====     ======     ======        ======





























                            See accompanying notes.



<PAGE>


                            ILM II LEASE CORPORATION

                            STATEMENTS OF CASH FLOWS
          For the nine months ended May 31, 1997 and 1996 (Unaudited)
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)

                                                             1997        1996
                                                             ----        ----

Cash flows from operating activities:
   Net income                                            $    269     $   303
   Adjustments to reconcile net income to
    net cash provided by operating activities
     Depreciation expense                                      30           -
     Changes in assets and liabilities:
      Accounts receivable                                    (322)          -
      Prepaid expenses and other assets                        24        (131)
      Deferred tax asset, net                                  21         (44)
      Accounts payable and accrued expenses                   122         453
      Accounts payable - affiliates                            64          16
      Real estate taxes payable                               (82)        147
      Security deposits                                         1          13
      Deferred rent payable                                   (23)        139
      Income taxes payable                                      -          62
                                                         --------     -------
         Total adjustments                                   (165)        655
                                                         --------     -------
         Net cash provided by operating activities            104         958

Cash flows from investing activities:
   Additions to furniture, fixtures and equipment            (163)          -
                                                         --------     -------
         Net cash used in investing activities               (163)          -

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

Net (decrease) increase in cash and cash equivalents          (59)      1,457

Cash and cash equivalents, beginning of period              1,591           -
                                                         --------     -------

Cash and cash equivalents, end of period                 $  1,532     $ 1,457
                                                         ========     =======

Supplemental disclosure:

Cash paid during the period for income taxes             $    216     $   173
                                                         ========     =======










                           See accompanying notes.



<PAGE>


                           ILM II LEASE CORPORATION

                        Notes to Financial Statements
                                 (Unaudited)


1. General

     The accompanying financial statements,  footnotes and discussions should be
     read in conjunction with the financial  statements and footnotes  contained
     in the  Company's  Annual Report for the year ended August 31, 1996. In the
     opinion of management,  the accompanying  financial statements,  which have
     not been audited,  reflect all adjustments  necessary to present fairly the
     results for the interim period. All of the accounting adjustments reflected
     in the accompanying  interim financial statements are of a normal recurring
     nature.

        The accompanying  financial statements have been prepared on the accrual
     basis of  accounting  in  accordance  with  generally  accepted  accounting
     principles which requires management to make estimates and assumptions that
     affect the reported  amounts of assets and  liabilities  and disclosures of
     contingent  assets and  liabilities  as of May 31, 1997 and August 31, 1996
     and revenues and  expenses  for each of the three- and  nine-month  periods
     ended May 31, 1997 and 1996. Actual results could differ from the estimates
     and assumptions used.

        The Company was formed by PaineWebber  Independent  Living Mortgage Inc.
     II (ILM) to operate nine rental  housing  projects for  independent  senior
     citizens   ("the  Senior   Housing   Facilities")   under  a  master  lease
     arrangement.  ILM has elected to be taxed as a Real Estate Investment Trust
     ("REIT") under the Internal  Revenue Code of 1986, as amended ("the Code"),
     for each taxable year of  operations.  In order to maintain its status as a
     REIT,  75% of ILM's annual gross income must be Qualified  Rental Income as
     defined  by the Code.  The rent  paid by the  residents  of the  Facilities
     likely would not be deemed to be  Qualified  Rental  Income  because of the
     extent of services  provided to residents.  Consequently,  the operation of
     the Facilities by ILM or its  subsidiaries  over an extended period of time
     could adversely  affect ILM's status as a REIT.  Therefore,  ILM formed the
     Company  to  operate  the  Senior  Housing  Facilities,  and by  means of a
     distribution,  transferred the ownership of the common stock of the Company
     to the  holders of ILM common  stock on  September  1,  1995.  Because  the
     Company,  which  is  taxed  as a  regular  C  corporation,  is no  longer a
     subsidiary  of  ILM,  it  can  receive   service-related   income   without
     endangering the REIT status of ILM.

        At a  meeting  of the  ILM  Board  on  January  10,  1997,  the  Advisor
     recommended the immediate sale of the senior housing facilities held by ILM
     and an affiliated  entity,  PaineWebber  Independent  Living Mortgage Fund,
     Inc.  ("ILM1"),  by  means  of a  controlled  auction  to be  conducted  by
     PaineWebber,  at no additional  compensation,  with PaineWebber offering to
     purchase  the  properties  for  $127  million,   thereby  guaranteeing  the
     shareholders a "floor"  price.  The Advisor also stated that if PaineWebber
     purchased  the  properties  at the  specified  price  and were then able to
     resell the properties at a higher price,  PaineWebber would pay any "excess
     profits" to the  shareholders.  To assist the Company and ILM in evaluating
     the Advisor's proposal, a disinterested, independent investment banker with
     expertise in healthcare REITs and  independent/assisted  living  financings
     was engaged.  Following a  comprehensive  analysis,  the investment  banker
     recommended that ILM decline the Advisor's proposal and instead investigate
     expansion and  restructuring  alternatives.  After  analyzing the Advisor's
     proposal  and the  recommendations  and other  information  provided by the
     independent investment banker, the Boards of ILM and ILM1 voted unanimously
     to  decline  the  Advisor's   proposal  and  to  explore  the  alternatives
     recommended by the independent  investment  banker.  The Boards declined to
     seek an immediate sale of the properties  because, in the Boards' view, the
     liquidation  price would not reflect the "going  concern"  value of ILM and
     ILM1 and, therefore, would not maximize shareholder value. In addition, the
     Boards did not  consider  it  advisable  to  liquidate  ILM and ILM1 on the
     suggested terms three years prior to their scheduled termination date.

        The Advisor had  indicated to the Board in its January 10, 1997 proposal
     that it would not wish to  continue  to serve as advisor  to ILM,  ILM1 and
     their affiliates if they declined to accept the Advisor's proposal. ILM and
     ILM1 have accepted the resignation of the Advisor, effective as of June 18,
     1997. The Advisor has agreed to continue to provide certain  administrative
     services  to ILM,  ILM1 and  their  affiliates  through  August  31,  1997,
     pursuant to the terms of a transition services agreement to be entered into
     with ILM,  ILM1 and their  affiliates.  The  Company,  ILM,  ILM1 and their
     affiliates  have  also  accepted,  effective  as  of  June  18,  1997,  the
     resignations  of those  officers  and  directors  who are  employees  of or
     otherwise  affiliated with the Advisor or its affiliates.  ILM and ILM1 are
     currently   evaluating  various  strategic   alternatives,   including  the
     possibility of becoming self-managed.

      In addition,  the Company and ILM continue to review various restructuring
   alternatives.  The  Company  and ILM are  analyzing  a merger of ILM with ILM
   Holding  and are also  considering  possibly  merging  ILM with  ILM1 and the
   Company with ILM I Lease Corporation.  In addition,  ILM is exploring listing
   its shares on an  exchange  or,  alternatively,  having  them  trade  through
   NASDAQ.  The  independent  investment  banker  is  also  in  the  process  of
   developing a new reorganization plan. The Company has not fully evaluated any
   of these  alternatives and is not in a position at this time to recommend any
   action to its  shareholders.  There can be no assurance that the Company will
   recommend taking any of such actions.

2.    The Master Lease Agreement

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

      Descriptions  of the  properties  covered by the master lease  between the
   Company and ILM Holding are summarized as follows:
                                                      Rentable  Date of
            Name                   Location           Units (1) Construction (2)
          
      The Palms                  Fort Myers, FL         205     October 1988
      Crown Villa                Omaha, NE              73      January 1992
      Overland Park Place        Overland Park, KS      139     June 1984
      Rio Las Palmas             Stockton, CA           164     June 1988
      The Villa at Riverwood     St. Louis County, MO   120     June 1985
      Villa Santa Barbara  (3)   Santa Barbara, CA      125     June 1979

       (1)    The number of rentable  units has been adjusted to account for the
              new  property   management   team's  current  program  of  placing
              non-rental units back into service.

       (2)    Date initial construction was completed.

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

      Terms of the Master Lease Agreement

      During the term of the master  lease,  the  Company  is  obligated  to pay
   annual base rent ("Base  Rent") for the  Facilities.  For calendar year 1995,
   the  annual  Base  Rent was  $3,548,700  (prorated  according  to the date of
   commencement  of the master  lease),  allocated as follows:  $849,836 for the
   Florida Facility, $541,010 for the Nebraska Facility, $720,252 for the Kansas
   Facility,  $591,429 for the Stockton,  California Facility,  $423,933 for the
   Missouri  Facility and $422,240 for the Santa Barbara,  California  Facility.
   For  calendar  years  1996  through  1999,  the  annual  Base  Rent  will  be
   $4,035,600, allocated as follows: $966,439 for the Florida Facility, $615,240
   for the Nebraska Facility, $819,074 for the Kansas Facility, $672,576 for the
   Stockton,  California  Facility,  $482,098  for  the  Missouri  Facility  and
   $480,173 for the Santa Barbara,  California Facility. For calendar year 2000,
   the annual Base Rent will be $3,555,427 (reflects rent reduction attributable
   to  termination  of lease for Villa Santa Barbara on December 31, 1999).  The
   master lease is a  "triple-net"  lease  whereby the Lessee pays all operating
   expenses,  governmental taxes and assessments,  utility charges and insurance
   premiums, as well as the costs of all required maintenance, personal property
   and  non-structural  repairs in  connection  with the operation of the Senior
   Housing  Facilities  ("Additional  Rent").  ILM  Holding,  as the Lessor,  is
   responsible  for major capital  improvements  and  structural  repairs to the
   Senior Housing  Facilities.  In addition,  beginning in the second quarter of
   fiscal  1997 and for the  remainder  of the lease  term,  the Company is also
   obligated to pay variable  rent  ("Variable  Rent") for each  Facility.  Such
   Variable Rent is payable  quarterly and equals 40% of the excess,  if any, of
   the aggregate total revenues for the Facilities, on an annualized basis, over
   $13,021,000.  Variable rent amounted to $261,000 for the six months ended May
   31, 1997.

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

3.    Related Party Transactions

      The  Advisor  receives a base fee in an amount  equal to 0.5% of the Gross
   Operating Revenues of the Facilities  operated by the Company as compensation
   for its services. This fee amounted to $54,000 and $48,000 for the nine-month
   periods ended May 31, 1997 and 1996, respectively.  In addition, an affiliate
   of the  Advisor  is  entitled  to  reimbursement  for  expenses  incurred  in
   providing certain financial,  accounting and investor  communication services
   to the Company.  Included in general and administrative  expenses for each of
   the  nine-month  periods  ended May 31, 1997 and 1996 is $44,000 and $23,000,
   respectively,  representing  reimbursements  to this affiliate of the Advisor
   for providing such services to the Company.

      As discussed in Note 1, ILM and ILM1 have accepted the  resignation of the
   Advisor  effective as of June 18, 1997.  The Company,  ILM and ILM1 and their
   affiliates  and the  Advisor  intend  to  enter  into a  transition  services
   agreement  pursuant to which the Advisor  would  continue to provide  certain
   administrative  services  to the  Company,  ILM,  ILM1 and  their  affiliates
   through August 31, 1997.

      The Company has retained Capital Senior Management 2, Inc.  ("Capital") of
   Dallas,  Texas to be the property  manager of the Senior  Housing  Facilities
   pursuant to a Management  Agreement  which  commenced  on July 29, 1996.  The
   initial term of the Management  Agreement expires on December 31, 2000, which
   coincides  with the  expiration  of the master  lease  agreement  between the
   Company  and ILM  Holding  described  in  Note  2.  Under  the  terms  of the
   Management  Agreement,  in the  event  that the  master  lease  agreement  is
   extended beyond December 31, 2000, the Management  Agreement will be extended
   as well, but not beyond July 29, 2001.  Effective in November 1996,  Lawrence
   A. Cohen, a Director of the Company and President,  Chief  Executive  Officer
   and Director of ILM, was also named Vice Chairman and Chief Financial Officer
   of Capital  Senior  Living  Corporation,  an affiliate of Capital.  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 is also eligible to earn an Incentive  Management Fee equal
   to 25% of the amount by which the average monthly Net Cash Flow of the Senior
   Housing  Facilities,  as defined,  for the twelve month period  ending on the
   last day of each calendar month exceeds a specified Base Amount.  Each August
   31,  beginning on August 31, 1997, the Base Amount will be increased based on
   the percentage  increase in the Consumer Price Index.  ILM has guaranteed the
   payment  of all  fees  due to  Capital  under  the  terms  of the  Management
   Agreement.  Capital  earned  total  management  fees of $549,000 for the nine
   months ended May 31, 1997.

      Accounts payable - affiliates at May 31, 1997 and August 31, 1996 includes
   advances of $294,000 and $225,000,  respectively,  received from ILM Holding,
   primarily for the purchase of personal property to operate the Senior Housing
   Facilities. The remaining balance of accounts payable - affiliates at May 31,
   1997 includes management fees payable to Capital of $54,000 and advisory fees
   payable to the Advisor of $18,000.  The remaining balance of accounts payable
   - affiliates at August 31, 1996 includes  management  fees of $60,000 payable
   to Capital and advisory fees payable to the Advisor of $17,000.

4. Contingencies

      A management  agreement  between ILM Holding and Angeles Housing Concepts,
   Inc.  ("AHC")  which  covered  the  management  of  all  six  Senior  Housing
   Facilities was assigned to the Company  effective  September 1, 1995. On July
   29,  1996,  the Company  and ILM Holding  ("the  Companies")  terminated  the
   property  management   agreement  with  AHC.  The  management  agreement  was
   terminated  for cause  pursuant to the terms of the contract.  Simultaneously
   with the  termination of the management  agreement,  the Companies,  together
   with certain affiliated entities, filed suit against AHC in the United States
   District  Court for the Eastern  District of Virginia for breach of contract,
   breach of fiduciary duty and fraud. The Company and ILM Holding allege, 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 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 an Answer with the Virginia  District
   Court  in  response  to  the  litigation  initiated  by the  Companies  and a
   Counterclaim   against  ILM  Holding.   The  Counterclaim  alleges  that  the
   management agreement was wrongfully terminated for cause and requests damages
   which  include the payment of a  termination  fee in the amount of  $750,000,
   payment of  management  fees  pursuant  to the  contract  from August 1, 1996
   through October 15, 1996, and recovery of attorney's  fees and expenses.  The
   aggregate  amount of  damages  against  all  parties  as  requested  in AHC's
   Counterclaim  exceeds  $2,000,000.  ILM has  guaranteed  the  payment  of the
   termination  fee at  issue  in  these  proceedings  to the  extent  that  any
   termination  fee is deemed  payable  by the  court and in the event  that the
   Company fails to perform pursuant to its contractual  obligations.  The court
   initially set a trial date of April 28, 1997 but, at AHC's request,  recently
   rescheduled  the trial for June 23, 1997.  On June 13, 1997 and July 8, 1997,
   the court issued Orders  purporting to enter judgment against ILM and ILM1 in
   the amount of $1,000,000.  In so doing,  the court  effectively  canceled the
   June 23, 1997 trial date.  The Orders do not contain any  findings of fact or
   conclusions of law. On July 10, 1997, the Company,  ILM, ILMI and ILM I Lease
   Corporation filed a notice of appeal to the United State Court of Appeals for
   the Fourth  Circuit  from the  Orders.  The  Company  intends  to  diligently
   prosecute  the  appeal.  The  eventual  outcome  of  this  litigation  cannot
   presently be  determined.  No provision for any liability  which might result
   from the  outcome  of this  matter  has  been  recorded  in the  accompanying
   financial statements.

      On February 4, 1997,  AHC filed a Complaint in the  Superior  Court of the
   State of California against Capital, Lawrence Cohen, and others alleging that
   the  defendants  intentionally  interfered  with  AHC's  property  management
   agreement with ILM Holding by inducing ILM Holding to terminate the agreement
   (the  "California  litigation").  The  complaint  seeks  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. Trial in the action has
   been set for  January  13,  1998 and  discovery  has just  begun.  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  Properties  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.  The
   Company's  Board also  concluded  that,  subject to certain  conditions,  the
   Company or its  affiliates  should  advance  up to $20,000 to pay  reasonable
   legal fees and  expenses  incurred by Capital in the  California  litigation.
   Subsequently the Boards of the Company and ILM I Lease  Corporation  voted to
   increase the maximum amount of the advance to $100,000. The defendants intend
   to  vigorously  defend  the  claims  made  against  them  in  the  California
   litigation.  The  eventual  outcome of this  litigation  cannot  presently be
   determined and, accordingly, no provision for any liability has been recorded
   in the accompanying financial statements.

5. Federal Income Taxes

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

      Deferred  income tax  expense  (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 May 31,
   1997  and  August  31,  1996  are  comprised  of the  following  amounts  (in
   thousands):
                                                         May 31      August 31
                                                         ------      ---------

         Deferred tax asset - straight-line
           rent expense                                  $    43      $  53
         Deferred tax liability - tax over 
           book amortization                                  26         15
                                                         -------      -----
    
                 Net deferred tax asset                  $    17      $  38
                                                         =======      =====


<PAGE>


      The  components  of income tax  expense  (benefit)  for the three and nine
   months ended May 31, 1997 and 1996 are as follows (in thousands):

                                   Three Months Ended      Nine  Months Ended
                                         May 31,                 May 31,
                                   ------------------      ------------------
                                     1997       1996        1997        1996
                                     ----       ----        ----        ----

            Current:
              Federal              $    -     $    67     $   134      $  209
              State                     -          12          24          37
                                   ------     -------     -------      ------
                 Total current          -          79         158         246
                                   ------     -------     -------      ------

            Deferred:
              Federal                   -           6          18         (37)
              State                     -           1           3          (7)
                                   ------     -------     -------      ------
                 Total deferred         -           7          21         (44)
                                   ------     -------     -------      ------
                                   $    -     $    86     $   179      $  202
                                   ======     =======     =======      ======

      The  reconciliation of income tax computed at U.S. federal statutory rates
   to income tax expense  for the nine months  ended May 31, 1997 and 1996 is as
   follows (in thousands):

                                                 1997                 1996
                                            -------------        -------------

            Tax at U.S. statutory rate      $   15    34%        $  172     34%
            State income taxes, net
            of federal tax benefit              27     6%            30      6%
                                            ------    ---        ------    ----
                                            $  179    40%        $  202     40%
                                            ======    ===        ======    ====






<PAGE>

                           ILM II LEASE CORPORATION

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

Liquidity and Capital Resources
-------------------------------

      ILM II  Lease  Corporation  (the  "Company")  was  formed  by  PaineWebber
Independent  Living Mortgage Inc. II ("ILM"),  a publicly-held,  non-traded Real
Estate  Investment  Trust  ("REIT"),  for the  purpose of  operating  six Senior
Housing Facilities under the terms of a master lease agreement.  ILM contributed
$500,000 in return for all of the issued and outstanding shares of the Company's
common stock.  ILM has elected to be taxed as a REIT under the Internal  Revenue
Code of 1986, as amended ("the Code"),  for each taxable year of operations.  In
order to maintain its status as a REIT, 75% of ILM's annual gross income must be
Qualified  Rental Income as defined by the Code.  The rent paid by the residents
of the  Facilities  likely  would not be deemed to be  Qualified  Rental  Income
because of the extent of  services  provided  to  residents.  Consequently,  the
operation of the Facilities by ILM or its  subsidiaries  over an extended period
of time could adversely affect ILM's status as a REIT. Therefore, ILM formed the
Company to operate the Facilities,  and by means of a distribution,  transferred
the  ownership  of the common  stock of the Company to the holders of ILM common
stock on September 1, 1995.  Because the Company,  which is taxed as a regular C
corporation,  is no longer a subsidiary  of ILM, it can receive  service-related
income without endangering the REIT status of ILM.

      The  Company's  sole  business  is the  operation  of the  Senior  Housing
Facilities.  The Company has leased the Senior  Housing  Facilities  from ILM II
Holding, Inc. ("ILM Holding"),  a majority-owned and consolidated  subsidiary of
ILM which currently  holds title to the  Facilities,  pursuant to a master lease
which  commenced on September 1, 1995 and expires on December 31, 2000 (December
31, 1999 with  respect to the Santa  Barbara  Facility).  The master  lease is a
"triple-net" lease whereby the Lessee pays all operating expenses,  governmental
taxes and assessments,  utility charges and insurance  premiums,  as well as the
costs of all required maintenance,  personal property and non-structural repairs
in connection with the operation of the Senior Housing Facilities.  ILM Holding,
as the Lessor,  is  responsible  for major capital  improvements  and structural
repairs to the Senior Housing Facilities.  During the initial term of the master
lease,  the Company is  obligated  to pay annual base rent for the use of all of
the  Facilities  in the aggregate  amount of  $3,548,700  for calendar year 1995
(prorated based on the commencement date of the lease),  $4,035,600 for calendar
years 1996 through 1999 and  $3,555,427  for calendar year 2000  (reflects  rent
reduction  attributable  to  termination  of lease for Villa  Santa  Barbara  on
December 31, 1999).  Beginning in the second  quarter of fiscal 1997 and for the
remainder of the lease term,  the Company is also obligated to pay variable rent
for each Facility. Such variable rent is payable quarterly and equals 40% of the
excess,  if any, of the  aggregate  total  revenues  for the  Facilities,  on an
annualized basis,  over $13,021,000.  Variable rent amounted to $261,000 for the
six months ended May 31, 1997.

      On July 29, 1996, the Company and ILM Holding ("the Companies") terminated
the property  management  agreement  with AHC  covering  the six Senior  Housing
Facilities  leased by the Company.  The management  agreement was terminated for
cause pursuant to the terms of the contract. Simultaneously with the termination
of the management  agreement,  the Companies,  together with certain  affiliated
entities,  filed suit against AHC in the United  States  District  Court for the
Eastern  District of Virginia for breach of contract,  breach of fiduciary  duty
and fraud.  The Company and ILM Holding  allege,  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 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 an
Answer with the Virginia District Court in response to the litigation  initiated
by the  Companies  and a  Counterclaim  against ILM  Holding.  The  Counterclaim
alleges that the management  agreement was  wrongfully  terminated for cause and
requests damages which include the payment of a termination fee in the amount of
$750,000,  payment of  management  fees  pursuant to the contract from August 1,
1996 through October 15, 1996, and recovery of attorney's fees and expenses. The
aggregate   amount  of  damages  against  all  parties  as  requested  in  AHC's
Counterclaim  exceeds  $2,000,000.   ILM  has  guaranteed  the  payment  of  the
termination fee at issue in these proceedings to the extent that any termination
fee is deemed  payable by the court and in the event that the  Company  fails to
perform pursuant to its contractual obligations. The court initially set a trial
date of April 28, 1997 but, at AHC's request, recently rescheduled the trial for
June 23,  1997.  On June 13,  1997 and July 8,  1997,  the court  issued  Orders
purporting to enter  judgment  against ILM and ILM1 in the amount of $1,000,000.
In so doing,  the court  effectively  canceled the June 23, 1997 trial date. The
Orders do not contain any  findings of fact or  conclusions  of law. On July 10,
1997,  the  Company,  ILM,  ILM1 and ILM I Lease  Corporation  filed a notice of
appeal to the United  State  Court of Appeals  for the Fourth  Circuit  from the
Orders.  The Company  intends to diligently  prosecute the appeal.  The eventual
outcome of this litigation cannot presently be determined.  No provision for any
liability  which might result from the outcome of this matter has been  recorded
in the accompanying financial statements.

            Subsequent to  terminating  the  management  agreement with AHC, the
Company retained Capital Senior Management 2, Inc.  ("Capital") of Dallas, Texas
to be the new manager of the Senior Housing Facilities  pursuant to a Management
Agreement  which  commenced on July 29, 1996. The initial term of the Management
Agreement  expires on December 31, 2000,  which coincides with the expiration of
the master lease agreement  between the Company and ILM Holding described above.
Under the terms of the Management Agreement,  in the event that the master lease
agreement is extended beyond December 31, 2000, the Management Agreement will be
extended as well,  but not beyond July 29,  2001.  Effective  in November  1996,
Lawrence A. Cohen,  a Director of the  Company and  President,  Chief  Executive
Officer and  Director of ILM, was also named Vice  Chairman and Chief  Financial
Officer of Capital Senior Living Corporation, an affiliate of Capital. Under the
terms of the Agreement,  Capital earns a Base  Management Fee equal to 4% of the
Gross Operating Revenues of the Senior Housing Facilities,  as defined.  Capital
is also eligible to earn an Incentive  Management Fee equal to 25% of the amount
by which the average monthly Net Cash Flow of the Senior Housing Facilities,  as
defined,  for the twelve  month period  ending on the last day of each  calendar
month exceeds a specified Base Amount.  Each August 31,  beginning on August 31,
1997, the Base Amount will be increased based on the percentage  increase in the
Consumer Price Index.  ILM has guaranteed the payment of all fees due to Capital
under the terms of the Management Agreement.

            On February 4, 1997,  AHC filed a Complaint in the Superior Court of
the State of California  against  Capital,  Lawrence Cohen,  and others alleging
that the defendants  intentionally  interfered  with AHC's  property  management
agreement  with ILM Holding by inducing ILM Holding to terminate  the  agreement
(the  "California  litigation").   The  complaint  seeks  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.  Trial in the action has
been set for January 13, 1998 and discovery  has just begun.  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
Properties  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.  The Company's Board also concluded
that,  subject to certain  conditions,  the  Company  or its  affiliates  should
advance up to $20,000 to pay  reasonable  legal fees and  expenses  incurred  by
Capital in the California  litigation.  Subsequently,  the Boards of the Company
and ILM I Lease  Corporation voted to increase the maximum amount of the advance
to $100,000.  The defendants intend to vigorously defend the claims made against
them in the  California  litigation.  The  eventual  outcome of this  litigation
cannot presently be determined and, accordingly,  no provision for any liability
has been recorded in the accompanying financial statements.

      The six properties  which the Company leases from ILM Holding averaged 92%
occupancy  for the quarter  ended May 31,  1997.  Current  annualized  operating
income levels are  sufficient  to cover the base master lease  payments at their
current annual level of $4,035,600,  which will remain in effect  throughout the
remaining term of the lease. As noted above,  the master lease also provides for
the payment of variable  rent  beginning in December  1996.  The Senior  Housing
Facilities  are currently  generating  gross revenues which are in excess of the
specified  threshold  in the variable  rent  calculation,  as discussed  further
above. Variable rent amounted to $261,000 for the six months ended May 31, 1997.
Further improvements in operating income levels are expected upon the successful
implementation of several new programs by the new property  management  company.
At many properties,  the management company has increased the number of rentable
units by asking the facility  managers to move off site.  The  increased  rental
revenue is  expected  to more than  offset any  additional  costs of housing the
managers and providing 24-hour coverage at the front desk. The live-in assistant
manager positions at several  properties are also being  eliminated,  which will
increase the number of rentable units. In addition, the management company is in
the process of implementing new marketing plans at several of the properties and
increasing rental rates at properties that have maintained high occupancy levels
and are  located in strong  markets.  Property  improvements  to be paid for the
Company during fiscal 1997 include new dining room carpeting at The Palms, and a
new on-site vehicle for The Villa at Riverwood.  Fiscal 1997 capital expenditure
plans to be funded by ILM include an ongoing program to replace air-conditioning
units at the Santa Barbara facility,  landscaping upgrades at Rio Las Palmas, as
well as planned roof repairs at Overland  Park Place and The Palms.  ILM is also
investigating  the potential for future  expansions of several of the facilities
which are  located in areas that have  particularly  strong  markets  for senior
housing.

      At a meeting of the ILM Board on January 10, 1997, the Advisor recommended
the  immediate  sale  of the  senior  housing  facilities  held  by  ILM  and an
affiliated entity,  PaineWebber Independent Living Mortgage Fund, Inc. ("ILM1"),
by  means  of a  controlled  auction  to  be  conducted  by  PaineWebber,  at no
additional  compensation,  with PaineWebber  offering to purchase the properties
for $127 million,  thereby  guaranteeing  the  shareholders a "floor" price. The
Advisor  also  stated  that  if  PaineWebber  purchased  the  properties  at the
specified  price and were then able to resell the  properties at a higher price,
PaineWebber  would pay any "excess profits" to the  shareholders.  To assist the
Company  and  ILM  in  evaluating  the  Advisor's  proposal,   a  disinterested,
independent   investment   banker  with   expertise  in  healthcare   REITs  and
independent/assisted  living  financings was engaged.  Following a comprehensive
analysis,  the  investment  banker  recommended  that ILM decline the  Advisor's
proposal and instead investigate expansion and restructuring alternatives. After
analyzing the Advisor's proposal and the  recommendations  and other information
provided by the independent  investment banker, the Boards of ILM and ILM1 voted
unanimously  to decline the Advisor's  proposal and to explore the  alternatives
recommended by the independent investment banker. The Boards declined to seek an
immediate sale of the properties  because,  in the Boards' view, the liquidation
price  would  not  reflect  the  "going  concern"  value  of ILM and  ILM1  and,
therefore, would not maximize shareholder value. In addition, the Boards did not
consider it  advisable to liquidate  ILM and ILM1 on the  suggested  terms three
years prior to their scheduled termination date.

      The Advisor had  indicated  to the Board in its January 10, 1997  proposal
that it would not wish to  continue  to serve as advisor to ILM,  ILM1 and their
affiliates if they declined to accept the Advisor's proposal.  ILM and ILM1 have
accepted  the  resignation  of the Advisor,  effective as of June 18, 1997.  The
Advisor  has agreed to continue to provide  certain  administrative  services to
ILM, ILM1 and their affiliates through August 31, 1997, pursuant to the terms of
a transition  services  agreement  to be entered  into with ILM,  ILM1 and their
affiliates.  The Company,  ILM, ILM1 and their  affiliates  have also  accepted,
effective as of June 18, 1997, the  resignations of those officers and directors
who are employees of or otherwise affiliated with the Advisor or its affiliates.
ILM and ILM1 are currently evaluating various strategic alternatives,  including
the possibility of becoming self-managed.

      In  addition,  the  Company  and  ILM are  continuing  to  review  various
restructuring  alternatives.  The Company and ILM are  analyzing a merger of ILM
with ILM Holding and are also considering possibly merging ILM with ILM1 and the
Company with ILM I Lease Corporation.  In addition, ILM is exploring listing its
shares on an exchange or,  alternatively,  having them trade through NASDAQ. The
independent  investment  banker  is  also in the  process  of  developing  a new
reorganization  proposal.  The  Company  has not  fully  evaluated  any of these
alternatives  and is not in a position at this time to  recommend  any action to
its  shareholders.  There can be no assurance  that the Company  will  recommend
taking any of such actions.

      At May 31, 1997, the Company had cash and cash  equivalents of $1,532,000.
Such amounts will be used for the Company's  working  capital  requirements.  As
noted above,  under the terms of the master lease, the Lessor is responsible for
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 in fiscal 1996.  The Company  intends to review this
policy during the second half of fiscal 1997 and may or may not determine to pay
cash  dividends  in the future.  Payment of  dividends,  if any,  will be at the
discretion of the Company's Board of Directors and will depend upon such factors
as the Company's  financial  condition,  earnings,  anticipated  investments and
other relevant  factors.  The source of future  liquidity is expected to be from
operating cash flow from the Senior Housing Facilities,  net of the master lease
payments to ILM Holding,  and interest  income earned on invested cash reserves.
Such  sources of  liquidity  are  expected to be adequate to meet the  Company's
operating requirements on both a short-term and long-term basis.

Results of Operations
Three Months Ended May 31, 1997
-------------------------------

      The  Company had a net loss of $1,000 for the three  months  ended May 31,
1997,  as compared  to net income of  $216,000  for the same period in the prior
year.  The  decrease  in net income is the result of an  increase  in  operating
expenses of  $499,000.  The  increase in  operating  expenses  was mainly due to
increases dietary expenses, general and administrative expenses and master lease
rent expense of $76,000,  $264,000 and $130,000,  respectively.  The increase in
dietary expenses primarily reflects an increase in the portfolio occupancy level
as compared to the same  period in the prior  year.  General and  administrative
expenses  increased largely due to an increase in legal fees attributable to the
ongoing AHC litigation and the analysis of restructuring  alternatives  referred
to above.  In  addition,  during the  current  three-month  period  the  Company
incurred  professional  fees related to the advisory services of the independent
investment  banker referred to above and for the  preliminary  evaluation of the
feasibility of completing expansions at certain of the facilities.  Master lease
rent expense increased due to additional variable rent accrued effective for the
second quarter of fiscal 1997 in accordance with the Master Lease Agreement. The
increases in operating  expenses were partially  offset by an increase in rental
income from the senior  housing  facilities of $283,000.  The increase in rental
income is mainly due  increases  in rental  rates at  certain of the  facilities
located in strong markets.  Due to the  unfavorable  change in the Company's net
operating  results,  income tax  expense  improved  by $86,000  for the  current
three-month period.

Nine Months Ended May 31, 1997
------------------------------

      The Company  reported net income of $269,000 for the nine months ended May
31, 1997, as compared to net income of $303,000 for the same period in the prior
year.  The  decrease  in net income is the result of an  increase  in  operating
expenses of  $1,104,000.  The increase in  operating  expenses was mainly due to
increases in dietary expenses,  general and  administrative  expenses and master
lease  rent  expense of  $238,000,  $388,000  and  $261,000,  respectively.  The
increase in dietary  expenses  primarily  reflects an increase in the  portfolio
occupancy  level as compared  to the same period in the prior year.  General and
administrative  expenses  increased  largely  due to an  increase  in legal fees
attributable  to the ongoing AHC  litigation  and the analysis of  restructuring
alternatives  referred to above.  In  addition,  during the  current  nine-month
period the Company incurred  professional  fees related to the advisory services
of the independent  investment  banker referred to above and for the preliminary
evaluation  of the  feasibility  of  completing  expansions  at  certain  of the
facilities.  Master lease rent expense increased due to additional variable rent
accrued  effective for the second quarter of fiscal 1997 in accordance  with the
Master Lease  Agreement.  The  increases in operating  expenses  were  partially
offset by an increase in rental  income from the senior  housing  facilities  of
$1,043,000.  The  increase  in  rental  income  is  due  to an  increase  in the
portfolio's average occupancy level, mainly due to the leasing activity at Villa
Santa Barbara, as well as increases in rental rates at certain of the facilities
located in strong markets. Due to the decline in net income,  income tax expense
declined by $23,000 for the current nine-month period.



<PAGE>



                                   PART II
                              Other Information

Item 1. Legal Proceedings

     In the litigation involving the Company,  ILM II Holding,  Inc. and Angeles
Housing Concepts,  Inc. that was reported in the Company's Annual Report on Form
10-K for the year ended August 31, 1996 and the  Company's  Quarterly  Report on
Form 10-Q for the quarter ended February 28, 1997,  the court,  on June 13, 1997
and July 8, 1997,  issued Orders  purporting to enter  judgment  against ILM and
ILM1 in the amount of $1,000,000.  In doing so, the court  effectively  canceled
the June 23, 1997 trial date.  The Orders do not contain any findings of fact or
conclusions  of law. On July 10, 1997,  the Company,  ILM,  ILM1 and ILM I Lease
Corporation  filed a notice of appeal to the United  States Court of Appeals for
the Fourth Circuit from the Orders. The Company intends to diligently  prosecute
the  appeal.  The  eventual  outcome  of this  litigation  cannot  presently  be
determined.  No provision for any liability  which might result from the outcome
of this matter has been recorded in the accompanying financial statements.

Item 2. through 5.            NONE

Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits:                NONE

(b)  Reports on Form 8-K:     NONE



<PAGE>

                           ILM II 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.




                          By: ILM II LEASE CORPORATION



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




Dated:  July 18, 1997