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 November 30, 1996

                                      OR

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

                     For the transition period from to .


                       Commission File Number: 0-25880


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


        Virginia                                              04-3248639
(State 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 November 30, 1996:  5,180,941.  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
               November 30, 1996 and August 31, 1996 (Unaudited)
                                (In thousands)

                                    ASSETS

                                                   November 30    August 31
                                                   -----------    ----------

Cash and cash equivalents                           $ 1,534        $  1,591
Accounts receivable                                       9               5
Prepaid expenses and other assets                        94             118
                                                    -------        -------
      Total current assets                            1,637           1,714

Furniture, fixtures and equipment                       199             197
Less:  accumulated depreciation                         (21)           (14)
                                                    -------        -------
                                                        178            183

Deferred tax asset, net                                  30             38
                                                    -------        -------
                                                    $ 1,845        $ 1,935
                                                    =======        =======


                     LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued expenses              $    391        $   503
Real estate taxes payable                                 -            203
Accounts payable - affiliates                           334            327
Security deposits                                        11             12
                                                   --------        -------
      Total current liabilities                         736          1,045

Deferred rent payable                                   123            131
                                                   --------        -------
      Total liabilities                                 859          1,176

Shareholders' equity                                    986            759
                                                   --------        -------
                                                   $  1,845        $  1,935
                                                   ========        ========













                            See accompanying notes.


<PAGE>


                            ILM II LEASE CORPORATION

                              STATEMENTS OF INCOME
        For the three months ended November 30, 1996 and 1995 (Unaudited)
                      (In thousands, except per share data)


                                            1996               1995
                                            ----               ----
Revenues:
  Rental and other income               $  3,576          $  3,165
  Interest income                             10                 4
                                        --------          --------
                                           3,586             3,169

Expenses:
  Master lease rent expense                1,001             1,001
  Dietary salaries, wages and food 
     service expenses                        659               547
  Administrative salaries, wages 
     and expenses                            252               238
  Marketing salaries, wages and expenses     152               160
  Utilities                                  266               245
  Repairs and maintenance                    126               127
  Real estate taxes                          125               123
  Property management fees                   192               175
  Other property operating expenses          382               314
  General and administrative                  27                20
  Advisory fees                               18                16
  Depreciation expense                         7                 -
                                        --------          --------
                                           3,207             2,966
                                        --------          --------

Income before taxes                          379               203

Income tax expense (benefit):
  Current                                    145               123
  Deferred                                     7               (42)
                                        --------          --------
                                             152                81
                                        --------          --------

Net income                              $    227          $    122
                                        ========          ========


Earnings per share of common stock         $0.04             $0.02
                                           =====             =====

The above earnings 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

                  STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
        For the three months ended November 30, 1996 and 1995 (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                          -       -         -        122        122
                                -----    ----     -----      -----      -----

Balance at November 30, 1995    5,181    $ 52     $  448     $  121     $ 621
                                =====    ====     ======     ======     =====

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

Net income                          -       -         -        227        227
                                -----    ----     ------     ------     -----

Balance at November 30, 1996    5,181    $ 52     $  448     $  486     $ 986
                                =====    ====     ======     ======     =====
























                           See accompanying notes.


<PAGE>


                            ILM II LEASE CORPORATION

                            STATEMENTS OF CASH FLOWS
        For the three months ended November 30, 1996 and 1995 (Unaudited)
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)


                                                             1996        1995
                                                             ----        ----
Cash flows from operating activities:
   Net income                                             $   227      $  122
   Adjustments to reconcile net income  to
    net cash (used in) provided by operating activities
     Depreciation expense                                       7           -
     Changes in assets and liabilities:
      Accounts receivable                                      (4)        (87)
      Prepaid expenses and other assets                        24        (157)
      Deferred tax asset, net                                   8         (42)
      Accounts payable and accrued expenses                  (112)        325
      Accounts payable - affiliates                             7          16
      Real estate taxes payable                              (203)         66
      Security deposits                                        (1)          -
      Deferred rent payable                                    (8)        114
      Income taxes payable                                      -         123
                                                          --------     ------
         Total adjustments                                   (282)        358
                                                          --------     ------
         Net cash (used in) provided by operating
           activities                                         (55)        480

Cash flows from investing activities:
   Additions to furniture, fixtures and equipment              (2)          -
                                                          --------     ------
 
         Net cash used in investing activities                 (2)          -

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          (57)        979

Cash and cash equivalents, beginning of period              1,591           -
                                                          --------     ------
 
Cash and cash equivalents, end of period                  $ 1,534      $  979
                                                          =======      ======

Supplemental disclosure:

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


                           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 November 30, 1996 and August 31,
     1996 and revenues and  expenses for each of the three month  periods  ended
     November 30, 1996 and 1995.  Actual results could differ from the estimates
     and assumptions used.

2.    The Master Lease Agreement

      The Company was formed by PaineWebber  Independent Living Mortgage Inc. II
   (ILM) to operate six rental housing projects for independent  senior citizens
   ("the Senior Housing  Facilities") under a master lease arrangement.  ILM 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.

      The  Company's  sole  business  is the  operation   of the Senior  Housing
   Facilities.  The Company has initially  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).



<PAGE>


      Descriptions  of the  properties  covered by the master lease  between the
   Company and ILM Holding are summarized as follows:
<TABLE>
                                                                          Date of
            Name                      Location        Rentable Units      Construction (1)
      <S>                           <C>                   <C>             <C>

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

      (1)   Date initial construction was completed.

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

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

      During the term of the master  lease,  the  Company  is  obligated  to pay
   annual base rent ("Base  Rent") for the  Facilities.  For calendar year 1995,
   the  annual  Base  Rent was  $3,548,700  (prorated  according  to the date of
   commencement  of the master  lease),  allocated as follows:  $849,836 for the
   Florida Facility, $541,010 for the Nebraska Facility, $720,252 for the Kansas
   Facility,  $591,429 for the Stockton,  California Facility,  $423,933 for the
   Missouri  Facility and $422,240 for the Santa Barbara,  California  Facility.
   For  calendar  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 January 1997 and for the
   remainder  of the lease  term,  the  Company  will also be  obligated  to pay
   variable rent ("Variable Rent") for each Facility. Such Variable Rent will be
   payable  quarterly and will equal 40% of the excess, if any, of the aggregate
   total revenues for the Facilities, on an annualized basis, over $13,021,000.



<PAGE>


      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  $18,000  and  $16,000  for  the
   three-month  periods  ended  November  30,  1996 and 1995,  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 the  three-month  periods  ended  November 30, 1996 and 1996 is
   $15,000  and  $19,000,  respectively,  representing  reimbursements  to  this
   affiliate of the Advisor for providing such services to the Company.

      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 Agreement,  Capital will earn a Base  Management Fee equal to 4%
   of the Gross Operating Revenues of the Senior Housing Facilities, as defined.
   Capital  will also be eligible to earn an Incentive  Management  Fee equal to
   25% of the amount by which the  average  monthly  Net Cash Flow of the Senior
   Housing  Facilities,  as defined,  for the twelve month period  ending on the
   last day of each calendar month exceeds a specified Base Amount.  Each August
   31,  beginning on August 31, 1997, the Base Amount will be increased 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 $192,000 for the three
   months ended November 30, 1996.

      Accounts  payable -  affiliates  at November  30, 1996 and August 31, 1996
   includes advances of $227,000 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 November 30, 1996 includes  management  fees payable to Capital
   of $63,000 and advisory fees payable to the Advisor of $18,000. The remaining
   balances  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.



<PAGE>


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 with the Virginia  District  Court an
   Answer  in  response  to the  litigation  initiated  by the  Companies  and a
   Counterclaim   against  ILM  Holding.   The  Counterclaim  alleges  that  the
   management agreement was wrongfully terminated for cause and requests damages
   which  include the payment of 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.  ILM
   has  guaranteed  the  payment  of the  termination  fee  at  issue  in  these
   proceedings.  The Companies  intend to  diligently  prosecute the case and to
   vigorously defend the counterclaims made by AHC. The eventual outcome of this
   termination dispute cannot presently be determined. Accordingly, no provision
   for any liability which might result from the outcome of this matter has been
   recorded in the accompanying financial statements.

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 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 November 30, 1996 and
   August 31, 1996 are comprised of the following amounts (in thousands):

                                                  November 30       August 31
                                                  -----------       ---------

      Deferred tax asset - straight-line 
          rent expense                              $  49            $  53
      Deferred tax liability - tax over 
          book amortization                            19               15
                                                    -----            -----
           Net deferred tax asset                   $  30            $  38
                                                    =====            =====



<PAGE>


      The components of income tax expense  (benefit) for the three months ended
   November 30, 1996 and 1995 are as follows (in thousands):

                                         1996              1995
                                         ----              ----

            Current:
              Federal                  $  123             $ 105
              State                        22                18
                                       ------             -----
                 Total current            145               123
                                       ------             -----

            Deferred:
              Federal                       6               (36)
              State                         1                (6)
                                       ------             -----
                 Total deferred             7               (42)
                                       ------             -----
                                       $  152             $  81
                                       ======             =====

      The  reconciliation  of income tax  computed at U.S.  federal  statutory
   rates to income tax expense is as follows (in thousands):

                                                 1996                1995
                                             -----------          ----------

            Tax at U.S. statutory rates      $  129   34%         $ 69   34%
            State income taxes, net
            of federal tax benefit               23    6%           12    6%
                                             ------  ----         ----   ---
                                             $  152   40%         $ 81   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 initially 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 January  1997 and for the
remainder of the lease term,  the Company will also be obligated to pay variable
rent for each  Facility.  Such variable rent will be payable  quarterly and will
equal  40% of the  excess,  if any,  of the  aggregate  total  revenues  for the
Facilities, on an annualized basis, over $13,021,000.

       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
with the  Virginia  District  Court an  Answer  in  response  to the  litigation
initiated  by  the  Companies  and  a  Counterclaim  against  ILM  Holding.  The
Counterclaim alleges that the management agreement was wrongfully terminated for
cause and requests damages which include the payment of 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.  ILM has  guaranteed  the payment of the  termination  fee at issue in
these proceedings.  The Companies intend to diligently prosecute the case and to
vigorously  defend the  counterclaims  made by AHC. The eventual outcome of this
termination  dispute cannot presently be determined.  Accordingly,  no provision
for any  liability  which might  result from the outcome of this matter has been
recorded in the accompanying financial statements.

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

      The six properties  which the Company leases from ILM Holding averaged 95%
occupancy for the quarter ended November 30, 1996. 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 January  1997.  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. Accordingly,  the Company expects that it will owe variable rent payments
to ILM Holding in fiscal 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 is
exploring the  potential to increase 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. Management of the
Company and ILM are currently  reviewing  annual  operating  budgets and capital
expenditure  plans  with the new  property  management  team,  which  include an
ongoing program to replace air-conditioning units at the Santa Barbara facility,
as well as planned roof repairs at Overland Park Place and The Palms.

      At  November  30,  1996,  the  Company  had cash and cash  equivalents  of
$1,534,000.  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  fiscal 1997,  subsequent  to the
commencement of the variable rent payments  discussed  further above, and may or
may not determine to pay cash dividends in the future. Payment of dividends,  if
any,  will be at the  discretion  of the  Company's  Board of Directors and will
depend  upon  such  factors  as the  Company's  financial  condition,  earnings,
anticipated  investments  and  other  relevant  factors.  The  source  of future
liquidity  is expected to be from  operating  cash flow from the Senior  Housing
Facilities, net of the master lease payments to ILM Holding, and interest income
earned on invested cash  reserves.  Such sources of liquidity are expected to be
adequate to meet the Company's  operating  requirements on both a short-term and
long-term basis.



<PAGE>


Results of Operations
Three Months Ended November 30, 1996
------------------------------------

      The Company's net income  increased by $105,000 for the three months ended
November  30,  1996 when  compared  to the same  period in the prior  year.  The
increase in net income is primarily  the result of an increase in rental  income
from the Senior Housing Facilities of $411,000. The increase in rental income is
primarily due to an increase in the portfolio's average occupancy level from 88%
for the  first  quarter  of  fiscal  1996 to 95% for  the  current  quarter.  In
addition,  interest income increased by $6,000 due to an increase in the average
balance of invested cash equivalents  during the current quarter.  The increases
in rental  income and interest  income were  partially  offset by an increase in
operating  expenses of $241,000.  The increase in operating  expenses was mainly
due to an  increase  of $112,000  in dietary  salaries,  wages and food  service
expenses  primarily  associated with the improvement in the portfolio  occupancy
level discussed further above.  Increases in other property operating  expenses,
utilities and administrative  salaries,  wages and expenses of $68,000,  $21,000
and $14,000, respectively, also contributed to the overall increase in operating
expenses.  Income tax expense  increased  by $71,000 due to the  increase in net
operating income.



<PAGE>


                                   PART II
                              Other Information


Item 1. Legal Proceedings

     The status of the litigation involving the Company, ILM II Holding,  Inc.
and Angeles Housing  Concepts,  Inc. remains  unchanged from what was reported
in the  Company's  Annual  Report on Form 10-K for the year  ended  August 31,
1996.


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/ Timothy J. Medlock
                                  ----------------------
                                  Timothy J. Medlock
                                  Treasurer





Dated:  January 21, 1997