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

                                   FORM 10-KSB

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934.
    For the fiscal year ended     DECEMBER 31, 1998
                                       or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934.

For the transition period from _____________________ to ________________________

                       Commission file number : 000-23321

                        DIVERSIFIED SENIOR SERVICES, INC.
        (Exact name of Small Business Issuer as specified in its charter)

NORTH CAROLINA                                                  56-1973923
(State or other jurisdiction of                             (I.R.S. Employer
incorporation or organization)                              Identification No.)

915 WEST 4TH STREET, WINSTON-SALEM, NC                           27101
(Address of principal executive offices)                      (Zip Code)

Registrant's telephone number, including area code:         (336) 724-1000
                                                            --------------

Securities registered pursuant to Section 12(b) of the Act:   None


Securities registered pursuant to Section 12(g)
of the Act:                                          Common Stock, no par value

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

As of February 28, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the closing price, was approximately
$4,593,810.

As of March 30, 1999, the registrant had 3,301,400 shares of Common Stock
outstanding.

Registrant's revenues for the fiscal year ended December 31, 1998 were
$3,644,157.

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

Transitional Small Business Disclosure Format          Yes___            No X


                      DOCUMENTS INCORPORATED BY REFERENCE

     The definitive Proxy Statement to be filed with the Securities and Exchange
Commission (the "Commission") with respect to the registrant's Annual Meeting of
Shareholders to be held in 1999 (the "1999 Proxy Statement") is incorporated by
reference into Part III of this Form 10-KSB.
<PAGE>
                                     PART I


          THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS FORWARDING-LOOKING
STATEMENTS WITHIN THE MEANING OF THAT TERM IN THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995 (THE ACT) (SECTION 27A OF THE SECURITIES ACT OF 1933 AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934). ADDITIONAL WRITTEN OR ORAL
FORWARD-LOOKING STATEMENTS MAY BE MADE BY THE COMPANY FROM TIME TO TIME, IN
FILINGS WITH THE SECURITIES EXCHANGE COMMISSION, PRESS RELEASES OR OTHERWISE.
STATEMENTS CONTAINED HEREIN THAT ARE NOT HISTORICAL FACTS ARE FORWARD-LOOKING
STATEMENTS MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE ACT.
FORWARD-LOOKING STATEMENTS MAY INCLUDE, BUT ARE NOT LIMITED TO, PROJECTIONS OF
REVENUE, INCOME OR LOSS AND CAPITAL EXPENDITURES, STATEMENTS REGARDING FUTURE
OPERATIONS, FINANCING NEEDS, ANTICIPATED COMPLIANCE WITH THE FINANCIAL COVENANTS
IN LOAN AGREEMENTS, PLANS FOR ACQUISITION OR SALE OF ASSETS OR BUSINESSES AND
CONSOLIDATION OF OPERATIONS OF NEWLY ACQUIRED BUSINESSES, AND PLANS RELATING TO
PRODUCTS OR SERVICES OF THE COMPANY, ASSESSMENTS OF MATERIALITY, PREDICTIONS OF
FUTURE EVENTS AND THE EFFECTS OF PENDING AND POSSIBLE LITIGATION, AS WELL AS
ASSUMPTIONS RELATING TO THE FOREGOING. IN ADDITION, WHEN USED IN THIS
DISCUSSION, THE WORDS "ANTICIPATES," "BELIEVES," "ESTIMATES," "EXPECTS,"
"INTENDS," "PLANS" AND VARIATIONS THEREOF AND SIMILAR EXPRESSIONS ARE INTENDED
TO IDENTIFY FORWARD-LOOKING STATEMENTS.

          FORWARD-LOOKING STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND
UNCERTAINTIES, SOME OF WHICH CANNOT BE PREDICTED OR QUANTIFIED BASED ON CURRENT
EXPECTATIONS. CONSEQUENTLY, FUTURE EVENTS AND ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE SET FORTH IN, CONTEMPLATED BY, OR UNDERLYING THE FORWARD
LOOKING STATEMENTS CONTAINED IN THIS ANNUAL REPORT, OTHER FILINGS, PRESS
RELEASES OR OTHERWISE. STATEMENTS IN THIS ANNUAL REPORT, PARTICULARLY IN "ITEM
1. DESCRIPTION OF BUSINESS," "ITEM 3. LEGAL PROCEEDINGS", THE NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS AND "ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," DESCRIBE CERTAIN
FACTORS, AMONG OTHERS, THAT COULD CONTRIBUTE TO OR CAUSE SUCH DIFFERENCES. OTHER
FACTORS THAT COULD CONTRIBUTE TO OR CAUSE SUCH DIFFERENCES INCLUDE, BUT ARE NOT
LIMITED TO, UNANTICIPATED DEVELOPMENTS IN ANY ONE OR MORE OF THE FOLLOWING
AREAS: ENVIRONMENTAL ISSUES, GOVERNMENT REGULATIONS, LABOR COSTS, LIABILITY AND
INSURANCE, PENDING OR THREATENED LITIGATION AND INVESTIGATIONS, THE DEPENDENCE
ON KEY PERSONNEL, THE OPERATION OF MANAGEMENT INFORMATION AND COMPUTER SYSTEMS
AT THE COMPANY'S CUSTOMERS AND VENDORS, ESPECIALLY AS IT RELATES TO THE YEAR
2000 ISSUE, AND OTHER RISKS FACTORS WHICH MAY BE DETAILED FROM TIME TO TIME IN
THE COMPANY'S SECURITIES AND EXCHANGE COMMISSION FILINGS.

          READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THE DATE
HEREOF. THE COMPANY UNDERTAKES NO OBLIGATIONS TO PUBLICLY RELEASE THE RESULT OF
ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS THAT MAY BE MADE TO REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNEXPECTED EVENTS.

ITEM 1.  DESCRIPTION OF BUSINESS.

GENERAL

          Diversified Senior Services, Inc. (the "Company") was founded to focus
on the development and management of low and moderate income senior housing and
assisted living facilities. Management believes that there is a growing demand
for senior housing developed for the low and moderate income frail elderly,
specifically in the Company's targeted areas of smaller cities and towns
throughout the Midatlantic and Southeast. Although the Company has been
operating for less than three years, through affiliates of the Company, senior
management has over 20 years of experience in developing and operating housing
specifically designed for this target population with a concentration in Eastern
North Carolina.

          The Company was formed in May 1996 as a wholly owned subsidiary of
Taylor House Enterprises, Limited ("THE") and began operations in July 1996 when
THE exchanged all of the stock of its wholly owned subsidiary Residential
Properties Management ("RPM") for Company common stock. THE is a privately-held
corporation controlled by the Company's senior management. RPM was formed in
1989 to manage low and moderate income housing developed by RPM affiliates.
Diversified completed its initial public offering in January 1998 and is quoted
under the symbol DISS on the Nasdaq Small Cap Market.

          In August 1996, the Company started a licensed home care agency in
Raleigh, North Carolina providing personal care services to supplement the
services provided at its concentration of senior housing properties located

                                       1

<PAGE>

in Eastern North Carolina. In addition, the Company began development of its
60-unit assisted living prototype, explored strategic alliances with nonprofit
organizations with interest in providing quality assisted living facilities for
the low and moderate income frail elderly and began locating sites for future
development. These activities continued during 1998 with the addition of a
30-unit independent senior housing product.

          The Company began construction on five 60-unit assisted living
residences and two 30-unit senior housing residences during 1998. Construction
of 60-unit facilities located in Mocksville and Hamlet North Carolina is
expected to be completed in May 1999. Completion of 60-unit facilities in
Cherryville, Rocky Mount and Goldsboro North Carolina is expected by the end of
1999. The first 30-door residences in Pittsboro and Kinston North Carolina are
scheduled to open in the fall of 1999.

          In October 1998 the Company began managing an assisted living property
in South Boston, Virginia for an affiliated owner. The property, completed in
April 1998, is licensed for up to 64 residents but is configured for 43
residents.

          In addition to the properties described above, at December 31, 1998,
the Company's development pipeline included four additional 60-unit sites and
five additional 30-unit sites under Company control and with positive
feasibility studies. The Company has identified sites in nine additional markets
with positive feasibility studies completed. The Company is also exploring the
conversion to assisted living of two residential floors in one existing
subsidized senior housing complex managed by the Company.

          It is anticipated that of the seven properties currently under
construction, four will be owned by a nonprofit organization which will purchase
the properties using tax-exempt bond or FHA-insured financing. Prior to the
closing of the applicable financing, the properties are owned by THE. The
remaining three properties will continue to be owned by THE and operated by the
Company until operations are stabilized. THE is providing the Company with
off-balance sheet financing for these properties, commonly referred to as "black
box" financing. However, unlike other black box arrangements, THE does not
expect to profit from the financing arrangement, except from the benefits of tax
deferral during development and fill-up. The Company has the right to purchase
the residences at THE's effective cost, which cannot exceed fair market value.

          As of December 31, 1998, the Company manages 51 residences, consisting
of approximately 2,079 units located in four states, North Carolina,
Pennsylvania, Virginia and West Virginia. Management contracts covering these
units have initial terms of one to three years, with varying renewal provisions.
The Company controls 16 facilities, representing approximately 869 units,
through direct ownership of management rights and through control of management
rights by an affiliate. Currently management fees provide the majority of the
Company's revenues. The Company also provides approximately 1,300 hours of home
care services per month.

          The Company intends to grow through internal development of facilities
and through acquisitions. The Company's internal growth program will be focused
on developing and operating 60-unit assisted living facilities and 30-unit
independent senior housing residences. In addition to developing these new
facilities, the Company will consider acquiring a number of facilities that it
currently operates, but does not own and acquiring existing senior housing
properties and assisted living facilities, or the lease rights to them, from
independent third parties. It is management's intention to cluster all of these
facilities in order to capture the benefits of scale. The Company expects its
future senior housing residences to serve as the foundation to provide a
continuum of care for low to moderate income senior citizens.

          The Company specializes in creating affordable community living
alternatives for seniors with fixed incomes. The goal is to offer a continuum of
senior living arrangements: apartments managed specifically for the housing
needs of elderly persons; enhanced housing providing additional services for
convenient, worry free living; and, finally, assisted living residences when a
greater level of support is necessary.

          The Company's 30-unit independent living residences, known as
"Somerset House," provide residents 24-hour security and emergency call system,
housekeeping, linen service, nutritious meals and activities. Each Somerset
House is designed as a large house compatible in style with, and situated in, a
small town, residential neighborhood in close proximity to community resources
such as churches and the public library. Each house is

                                       2

<PAGE>

limited to 30 private apartments to assure a warm, home-like atmosphere. Each
apartment has a bedroom area, a living area, a Pullman style kitchen and a
private bath.

          The Company's 60-unit assisted living residences, known as "Somerset
Court," supplement the services provided in an independent setting by providing
personal care services, including medication monitoring, dressing, grooming,
mobility, home management and case management. Somerset Courts provide a
comfortable home-like environment with a range of common areas to accommodate
both large gatherings and small, more intimate groups. Each resident has a
furnished, fully carpeted living area with separate entrance and temperature
control.

          The Company has applied for trademark protection for both its Somerset
House and Somerset Court service marks.

ORGANIZATION

          The Company is organized into two divisions: (i) developing and
acquiring assisted living facilities and senior housing residences and (ii)
managing assisted living facilities, senior housing residences and apartments,
primarily for the elderly.

DEVELOPMENT DIVISION

          The Company has designed a 60-unit prototype assisted living residence
for development primarily in communities with a population under 75,000 and a
30-unit senior housing residence prototype with services for development
primarily in smaller communities with approximately 600 individuals in the
targeted population within the determined market area. The targeted resident for
the 60-unit residence is a low-to-moderate income, frail elderly individual with
moderate income equaling the area median income, and low income beginning at
approximately 50% of median income. The target resident for the 30-unit
residence is a moderate income, elderly individual who wants the security and
convenience of non-personal care services (meals, housekeeping, linen service,
24 hour security and social interaction). Based on its own industry surveys, the
Company believes that there are currently few competitors who have targeted the
Company's demographic and regional market: the low-to-moderate income frail
elderly population of the Midatlantic and Southeast, especially in rural areas.
Generally, the Company will target specific geographic areas where the only
existing competition is old style rest homes, home care and nursing homes.

          The Company breaks down development of assisted living and senior
housing facilities into three major phases as follows: (a) development
consisting of town and site selection, marketing and environmental studies,
acquiring local permits, obtaining financing and construction contracts (4 to 6
months); (b) construction (9 to 12 months); and (c) fill-up (3 to 9 months). The
Company intends to utilize both corporate and on-site marketing teams and
anticipates a period of 3 to 9 months to fill-up a location. With respect to the
60-unit prototype, management anticipates some private pay residents, but
intends to develop properties that can be profitable with only public pay
residents.

          As of December 31, 1998, the Company has seven facilities under
construction, nine sites under development and nine sites identified in markets
with positive feasibility studies completed. These sites are located in North
Carolina, South Carolina and Virginia. The Company intends to maintain a
geographic focus in North Carolina for its 60-unit assisted living facilities,
developing approximately two to four facilities at a time. The Company will
focus on smaller communities in North Carolina, South Carolina and Virginia for
the 30-unit senior housing residence, which will not currently qualify for
public assistance. In the future, the Company plans to advance into surrounding
states, maintaining the same focus on small to mid-sized communities with a
relatively large low and moderate income elderly population. Turnkey costs,
including all development fees to the Company, for the 60-unit prototype are
estimated to average $3,123,000 for the first five projects and $2,906,000 for
the first eight 30-unit residences.

          The Company has entered into two development agreements with a
non-profit housing entity that provide for the development of newly constructed
assisted living residences. One agreement relates to tax exempt bond financed
properties and the other agreement relates to FHA-insured financed properties.
Once a potential site is located, feasibility and due diligence are completed;
the prospective non-profit owner will make a final commitment to the site,
subject to financing. The Company is entitled to a base development fee equal to
10% of total

                                       3

<PAGE>

development costs, less the development fee. The Company may receive an
additional 5% development fee for a total maximum fee of 15% of development
costs, based on achieving certain performance goals and cost efficiencies.

          The Company's approach to individual markets for potential development
is centered on senior management's long-term experience with mid-size and rural
markets. Consequently, the Company performs thorough internal market analysis at
the beginning of the site acquisition process. This internal work is then
carefully reassessed by a third party market study just prior to entering into a
formal commitment to the development, which typically takes place when the site
is acquired and construction commences. Management believes that this approach
provides the safest way to ensure a feasible development in a timely and cost
efficient manner.

          The Company currently manages several subsidized apartment complexes
for low and moderate income elderly individuals, which meet many of the physical
requirements of a licensed assisted living facility. The facilities have wide
hallways, communal dining rooms, kitchens, laundry facilities, activity rooms
and other common areas available for use by residents. The Company is currently
working closely with its architect and the North Carolina Division of Facility
Services regarding the potential conversion of two floors of an existing
apartment complex to licensed assisted living.

MANAGEMENT DIVISION

          Affiliates of the Company have been in the business of developing and
managing senior housing for more than 20 years. Of the 51 residences currently
managed by the Company, the Company controls 16, representing 869 units, either
through the direct ownership of management rights or through ownership by an
affiliated entity. The remaining 35 complexes, representing 1,210 units, are
owned by third parties. Approximately 31% of the complexes are owned by
non-profit organizations.

          The Company manages housing in North Carolina, Pennsylvania, Virginia
and West Virginia. Generally the managed properties receive government subsidies
through favorable financing and/or direct rent contributions under programs
administered by Housing and Urban Development ("HUD") or Rural Development
("RD," formerly the Farmer's Home Administration). Management fees for
government assisted housing are frequently higher than fees for management of
conventional apartments because of the added layers of paperwork required to
comply with government programs. The Company typically receives a percentage of
rent revenues ranging from 6% to 8% or a flat monthly fee for occupied units. In
addition, the Company receives a stated monthly bookkeeping fee for all HUD
properties it manages. The management agreements are approved by the applicable
government agency and are relatively standardized. The initial term of a HUD
management contract is two years with one-year renewals thereafter. A typical RD
management contract has a three-year term and must be executed every three
years. The Company's conventional and assisted living management contracts have
initial terms of one to five years, with varying renewal provisions. The
Company's history of contract renewal has been excellent.

          All developed assisted living and senior housing residences will be
managed either under a management contract, cancelable only under very specific
conditions, or pursuant to a lease between the owner and a single purpose
wholly-owned subsidiary of the Company formed specifically for the project. The
term of the management contract or lease will be for a minimum of three years,
with renewals for a minimum of three years. In addition, the Company will have a
right of first refusal to purchase any project.

          Management views assisted living and senior housing operations as a
combination of home care services and real estate management services, both
current operations of the Company. Thus, this division will combine these two
skills in buildings that the Company will have developed and financed
specifically for the low and moderate income, frail elderly market. The Company
is currently providing home care services to low and moderate income frail
elderly residents at 10 of the apartment complexes that it manages as well as in
private homes. These home care services are funded by state Medicaid programs as
well as private payors. The home care services provided by the Company include
assistance with medication monitoring, dressing, grooming, personal hygiene,
mobility, home management, chorework and case management. It is the Company's
intention to continue to offer personal care services to its residents either
through its own staff, when economically prudent, or through quality third party
operators.

                                       4

<PAGE>

          Because many of the initial assisted living residences will be in
close proximity to existing apartment complexes managed by the Company,
management believes that through the sharing of certain personnel, mostly
maintenance and property staff, operating costs will be lowered. An additional,
very important benefit from the Company's experience managing low and moderate
income elderly properties is that it gives management excellent operating
histories to use as comparisons for the assisted living and senior housing
residences. However, perhaps most important for cross-marketing purposes,
through its apartment management division the Company has established
relationships with over a 1,000 low and moderate income elderly residents. These
relationships give the Company a unique platform from which to further its
assisted living operations.

COMPETITION

          The assisted living industry is highly competitive, fragmented,
characterized by numerous small operators but also with large, public,
well-financed competitors. The scope of assisted living services varies
substantially from one operator to another and with the requirements of one
state to another. The Company believes that residential style assisted living
offers an attractive approach to providing residential and personal care
services for the elderly, particularly in light of (i) the increased emphasis by
both federal and state governments on containing costs; (ii) limitations imposed
in many states on the construction of additional skilled nursing facilities,
which have generally increased the level of care provided in such facilities and
forced less acute elderly to seek alternative care arrangements; and (iii) the
decreasing viability of family care. The primary consumers of assisted living
and senior housing residences are persons over the age of 65.

          The competition in managing subsidized housing for the elderly is
substantial with competition from numerous local, regional and national
companies, many of which have greater financial resources than the Company.
There is increasing demand for such facilities due to the increasing population
of elderly in the United States. Growth in this industry is dependent upon the
availability of government financing and subsidies which are currently being
restricted and undergoing reassessment and change. The Company does not
anticipate substantial near-term growth in this part of its business and is not
dependent on such growth for future profitability. Management of the Company has
over twenty years experience in subsidized housing and extensive experience
interacting with governmental agencies, so the Company should be positioned to
take advantage of this business if and when conditions change.

REGULATORY MATTERS

          The assisted living operations of the Company are subject to
substantial regulation by federal, state and local governmental agencies.
Assisted living facilities are generally subject to less regulation than other
licensed health care providers are, but more regulation than standard congregate
care or independent living facilities. However, the Company anticipates that the
states and the federal government will impose additional regulations and
licensing requirements. Currently, North Carolina requires licenses to provide
the assisted living services provided by the Company but not a certificate of
need. In August 1997, the North Carolina General Assembly enacted a twelve-month
moratorium on newly licensed beds while licensure procedures are studied to
determine whether the existing licensure procedures need to be modified. In 1998
the moratorium was extended for another twelve months. It is anticipated that
the moratorium will result in stricter licensure procedures in North Carolina.
The Company has received confirmation from the Division of Facilities Services
that its nine feasible sites are exempt from the moratorium.

          North Carolina also has regulations applicable to facilities that are
not technically assisted living providers but still offer substantially similar
services. The regulations primarily require a notice filing with the state and
are intended to assure that residents are given sufficient information to choose
providers of personal care services that the facility is not licensed to
provide. Although the Company does not believe its 30-unit senior housing
residence is subject to this regulation, the Company may elect to register its
30-unit facilities until the applicability of the regulation is clarified.

          The licensing statutes typically establish physical plant
specifications, resident care policies and services, administration and staffing
requirements, financial requirements, emergency service procedures plus after
construction approval of the as-built building and the Company's operating
policies and procedures. The Company's facilities must also comply with the
requirements of the Americans With Disabilities Act and are subject to various
local building codes and other ordinances, including fire safety codes. The
Company is a provider of services under

                                       5

<PAGE>

Medicaid programs and is subject to Medicaid regulations designed to limit fraud
and abuse, violations of which could result in civil and criminal penalties and
exclusion from participation in Medicaid programs. The Company believes it is in
substantial compliance with all applicable regulatory requirements. No actions
are pending against the Company for non-compliance with any regulatory
requirement.

          The North Carolina assisted living facilities are anticipated to
derive a substantial portion of their revenues from the Division of Social
Services ("DSS") and the Division of Medical Assistance ("DMA"), both under the
North Carolina Department of Health and Human Services. DSS administers the
state program for Special Assistance for Adults ("SA"), and DMA administers the
Medicaid program including the reimbursement to assisted living facilities for
personal care assistance ("ACH/PC"). In general, persons with incomes under
$12,058 per year are eligible to receive payments under SA and ACH/PC. DSS
applies a sliding scale to determine the percentage of SA it will pay, with the
resident being responsible for any remaining portion.

          The North Carolina General Assembly sets the SA and ACH/PC rates.
Effective October 1, 1998, the basic SA rate was set at $956 per month and the
basic ACH/PC rate was set at $9.15 per day. For residents that require a higher
level of care and are deemed to be "enhanced care" residents the ACH/PC rate
paid in addition to basic SA is as follows:

Extra assistance with eating                                 $18.12 per day
Extra assistance with toileting                              $12.35 per day
Extra assistance with eating and toileting                   $21.35 per day

"Enhanced care" residents are those who need extensive assistance or are totally
dependent on other persons for eating, toileting or both.

          Finally, an allowance of $ .50 per day is paid by Medicaid to fund
medically related resident transportation.

          Subsidized apartments are also subject to substantial regulations
primarily from HUD/FHA and the Rural Development Agency, as applicable. In most
states, subsidized apartments are also subject to state and local building and
fire codes. Approximately 56% of the units under management are eligible for
rent subsidies under Housing Assistance Payment ("HAP") contracts. The treatment
of HAP contracts upon expiration is under review by the United States Congress.
No current HAP contract affecting the Company's managed properties is up for
renewal until 1999. The effect of the expiration of an individual property's HAP
contract without renewal varies and depends on the HUD determined fair market
rent for the specific market area.

          Providers of personal care services in North Carolina must obtain a
license from the Division of Facility Services of the North Carolina Department
of Health and Human Services. There are different levels of licensure depending
on the nature of the services provided. A provider must obtain a Certificate of
Need ("CON") to participate in the Medicare-funded Home Health Program, which
generally entails the provision of skilled medical services and therapies. No
CON is required to participate in the Medicaid funded personal care service
("PCS") program, which is available to the low income elderly in their place of
residence, nor the Community Access Program ("CAP"), which provides extensive
personal care and related services for the low income disabled. The Company
participates in both the PCS and CAP programs. The reimbursement rate is
currently $12.13 per hour. Eligible participants in the PCS program can receive
up to a maximum of 80 hours of personal care services each month. Services
include assistance with the basic activities of daily living, including bathing,
dressing, grooming, transfers, personal hygiene, assistance with medication
monitoring, maintaining a safe and clean environment, household management and
simple meal preparation. The Company's personal care revenues for 1997 and 1998
were funded 90% and 48%, respectively by the Medicaid PCS program.

ENVIRONMENTAL MATTERS

          Under various federal, state and local environmental laws, ordinances
and regulations, a current or previous owner or operator of real property may be
held liable for the cost of removal or remediation of certain hazardous or toxic
substances, including, without limitation, asbestos-containing materials that
could be located on, in or under such property. Such laws and regulations often
impose liability whether or not the owner or operator knew of, or was
responsible for, the presence of the hazardous or toxic substances. The
Company's activities are not anticipated

                                       6

<PAGE>

to generate any environmentally controlled substance. With respect to the
Company's development activities, a Phase I environmental report is obtained on
all potential sites before acquisition. Although the Company is not aware of any
material environmental issues affecting any property it operates, as a
developer, owner and/or manager of real property environmental concerns could
impact the Company's operations.

EMPLOYEES

          As of December 31, 1998, the Company had 145 employees, 54 of whom are
full-time. None of the Company's employees are subject to collective bargaining
agreements and none of the employees have been on strike in the past three
years.


ITEM 2. DESCRIPTION OF PROPERTIES.

CORPORATE OFFICES

          The Company subleases 90% of the office and administrative building
located at 915 West Fourth Street, Winston-Salem, North Carolina from THE at a
monthly rent of $2,700 plus its share of property insurance and maintenance
expenses. There is no written sub-lease and the base lease between THE and an
independent third party has a remaining term of approximately one and one-half
years.

          The Company leases office space in Raleigh, North Carolina for both a
regional property team and the home care agency. The leased premises are
controlled by an affiliate and there is no written lease. The current monthly
rent equals the cost of the utilities used by the Company. The Company leases
office space in Port Royal, Pennsylvania from an unrelated third party for a
regional property team. The lease is for a term of one year.

          The Company leases office space in New York, New York from an
unrelated third party for a its subsidiary, DSS Funding, Inc. Rent payments are
approximately $2,200 per month, on a month-to-month basis. There is no written
lease.



PROPERTIES MANAGED

<TABLE>
<CAPTION>
           Property Name                                            City                    State           #Units

           Properties Currently Under Management

<S>        <C>                                                      <C>                       <C>             <C>
(1)        Adelaide Walters                                         Chapel Hill               NC              24
(1)        Agape Homes                                              Valdese                   NC              30
(1) (2)    Balsam Grove                                             Brevard                   NC              40
(1) (2)    Cape Fear                                                Wilmington                NC              89
(1)        Dogwoods                                                 Farmville                 NC              24
(1) (2)    Duplin County Housing for the Elderly                    Rose Hill                 NC              85
           Fiesta Drive Properties                                  Greensboro                NC              8
(1)        Hampton Woods I                                          Jackson                   NC              15
(1)        Hampton Woods II                                         Jackson                   NC              10
(1)        Heritage Homes                                           Henderson                 NC              50
(1)        Hobart Jackson Estates                                   Reidsville                NC              36
(2)        Hoffman Homes                                            Gastonia                  NC              81
           In-Chu-Co                                                Chapel Hill               NC              79
(1)        Jackson Village                                          Sylva                     NC              24
(1)        Kirkwood I                                               Goldsboro                 NC             100
(1)        Kirkwood II                                              Goldsboro                 NC              40
(1)        Lion's Senior Village                                    Shelby                    NC              40

                                       7

<PAGE>

           Morehead Glen                                            Durham                    NC              20
           Oaks at Spring Garden                                    Greensboro                NC             192
           Point South                                              Greensboro                NC              23
(1)        Prince Court                                             Rocky Mount               NC              30
(1) (2)    RM Wilson                                                Rocky Mount               NC              50
           Rolling Hills Townhomes                                  Salisbury                 NC              61
(1)        Scott Mitchell I                                         Norlina                   NC              14
(1)        Scott Mitchell II                                        Norlina                   NC              16
(1) (2)    Sir Walter                                               Raleigh                   NC             140
           The Summit at Cullowhee                                  Cullowhee                 NC              48
           The Summit at Cullowhee                                  Cullowhee                 NC              48
(2)        University Apartments                                    Durham                    NC             114
(1)        Wesbury                                                  Concord                   NC              50
(1)        Wesbury Plaza                                            Concord                   NC              40
           West Park                                                Durham                    NC              10
(2)        Yadkin Trail Homes                                       Raeford                   NC              48
           Big Valley Apartments                                    Reedsville                PA              12
           Brown Apartments                                         Reedsville                PA              20
           Cedar Acres I & II                                       Mifflintown               PA              32
(2)        Centre Estates I                                         Boalsburg                 PA              40
(2)        Centre Estates II                                        Boalsburg                 PA              40
           East Berlin Manor Apartments                             East Berlin               PA              19
           Evergreen Pointe                                         Danville                  PA              48
(2)        Fayette Acres                                            McAllisterville           PA              10
           Findlay Park                                             Mercersburg               PA              15
           Middlecreek Village                                      Kreamer                   PA              12
(1) (2)    North Street Manor                                       Mifflintown               PA              30
           Randall Brake Apartments                                 Mercersburg               PA              4
(2)        Rockwood Gardens II                                      Rockwood                  PA              10
(1) (2)    Southview Apartments                                     McAllisterville           PA              32
(1)        Susquehanna Apartments                                   Duncannon                 PA              28
(1) (2)    Tuscarora Acres I                                        Port Royal                PA              17
(1)        Tuscarora Acres II                                       Port Royal                PA              12
(2) (3)    Somerset Court of South Boston                           South Boston              VA              43
(1)        Senior Square                                            Elizabeth                 WV              24
(3)        60 Unit Properties Under Construction
(2)        Somerset Court of Mocksville                             Mocksville                NC              60
(2)        Somerset Court of Hamlet                                 Hamlet                    NC              60
(2)        Somerset Court of Rocky Mount                            Rocky Mount               NC              60
(2)        Somerset Court of Goldsboro                              Goldsboro                 NC              60
(2)        Somerset Court of Cherryville                            Rocky Mount               NC              60

                                       8


<PAGE>

         (130 Units Under Construction
(2)        Somerset House of Pittsboro                              Pittsboro                 NC              30
(2)        Somerset House of Kinston                                Kinston                   NC              30


NOTES

(1)  Senior housing

(2)  Controlled by an affiliate

(3)  Assisted living properties
</TABLE>


INVESTMENT POLICIES

          The Company's developed properties are generally owned by affiliates
or by third party nonprofit entities. The Company has the right to buy each
developed properties owned by an affiliate at the affiliate's cost, but not more
than fair market value, at any time after the Company determines that the
property has achieved stabilized operations. The definition of "stabilized
operations" is determined by the Company from time to time in its sole
discretion.


ITEM 3. LEGAL PROCEEDINGS

          The Company is not a party to any material pending legal proceedings.


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


          None.



                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

MARKET INFORMATION

          Effective January 10, 1998, the Common Stock of the Company was
approved for quotation on the Nasdaq Small Cap market under the symbol "DISS."
Accordingly, the Company's Common Stock did not trade during the year ended
December 31, 1997. The following table summarizes the high and low sales price
for the year ended December 31, 1998.

        QUARTER                HIGH              LOW

        First                  $6.125            $3.875
        Second                 $5.375            $3.500
        Third                  $5.938            $3.688
        Fourth                 $5.063            $3.000

                                       9


<PAGE>

HOLDERS OF RECORD

          There were approximately 14 shareholders of record of Common Stock as
of March 3, 1999. This number does not include beneficial owners holding shares
through nominees or "street" names. The Company believes that it has
approximately 500 beneficial holders of Common Stock.

DIVIDEND POLICY

          The Company has not paid any cash dividends on its Common Stock since
its inception and does not currently anticipate paying dividends on its Common
Stock in the foreseeable future. Management intends to reinvest earnings, if
any, in the development and expansion of the Company's business. Any future
declaration of cash dividends will be at the discretion of the Board of
Directors and will depend upon the earnings, capital requirements and financial
position of the Company, general economic conditions and other pertinent
factors.



ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

THE DISCUSSION AND ANALYSIS BELOW SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES TO FINANCIAL STATEMENTS.

OVERVIEW

          Diversified Senior Services, Inc. (the "Company") was formed in May
1996 as a wholly owned subsidiary of Taylor House Enterprises, Limited ("THE")
and began operations in July 1996. The Company was capitalized with $100 and its
parent, THE, received 100 shares of common stock. THE provided working capital
to the Company during its start-up phase. Upon formation, the Company agreed to
take responsibility for deferred salaries and bonuses for certain executives of
THE for the period January 1, 1996 through June 30, 1996.

          In July 1996, THE exchanged all of the stock of its wholly owned
subsidiary Residential Properties Management, Inc. ("RPM") for 2,277,678 shares
of the Company. RPM was formed in March 1989 to manage government subsidized
multi-family and elderly residential rental apartments. Effective June 30, 1997,
THE returned 477,778 shares of common stock to the Company which it retired
leaving 1,800,000 shares of common stock issued and outstanding. On January 14,
1998, the Company completed its initial public offering of 1,500,000 shares of
common stock On February 16, 1998, the Company formed a wholly-owned subsidiary,
DSS Funding, Inc. ("DSSF"), a North Carolina corporation, for the purpose of
securing permanent financing for the properties which the Company develops or
acquires for third party owners. On July 22, 1998, the Company formed a wholly
owned subsidiary, Diversified Senior Services of Virginia, Inc. ("DSSVA"), a
Virginia corporation, for the purpose of conducting development and management
of properties in Virginia.

          The Company anticipates a moderate growth in the number of apartment
units managed and also expects that income will increase due to inflationary
effects on rents. All personnel located at the apartments who manage the
apartments and perform maintenance are employees of the Company. However, the
apartments reimburse the Company for the services of the on site personnel. The
Company anticipates a moderate growth in reimbursement income as a result of
increases in salaries of on site personnel and an increase in the number of
apartment complexes under management.

          The Company began offering home care services in August 1996 at
selected apartment locations. Management anticipates that growth in home care
service income will continue at a moderate, controlled pace as it begins to
offer these services to elderly residents in other apartments that it manages.
However, management does not expect the income from these services to be
material with respect to the total income of the Company over the next several
years.

          The Company is in the process of developing 60-unit assisted living
residences in North Carolina and 30-unit independent senior housing residences
with services throughout the Southeast. As of February 28, 1999, the Company has
five 60-unit properties in the construction process, and an additional four
sites approved under the state's moratorium on new assisted living facilities.
The construction process is estimated to be nine to twelve months for each
60-unit assisted living residence. The Company began managing an assisted living
property for an affiliated owner

                                       10


<PAGE>

in October 1998. The property, located in South Boston, Virginia, is licensed
for up to 64 residents but currently configured for 43 residents. It was
completed in April 1998. The Company will provide working capital to this
facility to cover operating deficits while the Company is pursuing permanent
financing. The permanent financing involves a transfer of ownership to a not for
profit and provides for repayment of the working capital advances made by the
Company. With respect to the 30-unit residences, the Company has two sites under
construction and an additional five sites under control, all of which have
positive feasibility. The sites are in Virginia, South Carolina and North
Carolina. Once construction of these 60-unit and 30-unit residences is
completed, the Company will begin to recognize management fee income for those
properties. The Company is currently negotiating the private placement of
convertible preferred stock which will serve as the equity component for its
development plan. However, there can be no assurance that the Company will
consummate such financing, and if alternative financing cannot be arranged on
terms acceptable to the Company, the Company may not be able to complete its
current development plan on schedule. Management believes that in the future the
development and management of assisted living facilities and residences for the
elderly will provide the vast majority of the Company's revenues and profits.

          The Company is developing 30-unit and 60-unit properties for third
party owners. The Company recognizes development fee income on the percentage of
completion basis. Development costs are paid by the Company as incurred. Other
development costs are reimbursed by the purchaser when the property is sold. If
a site is abandoned, all development costs associated with that property are
written off.

          Most of the operating expenses of the Company are related to the
personnel directly performing the management services and the corporate
management staff. Between 70% and 90% of the expenses are for salaries, benefits
and payroll taxes. The remaining expenses are primarily administrative expenses
that support the activities of the personnel such as travel, rent, telephone and
office expenses. Since the Company's inception, the operating staff increases
have been due primarily to the entrance of the Company into the home care
business. However, the corporate staff has grown over that same period of time
because of the need to have adequate personnel in place to develop the assisted
living residences. Management expects that expenses associated with operating
personnel will continue to increase significantly as the Company expands, but
management does not expect to increase the number of corporate staff
significantly during the next several years.

          DSS, RPM and DSSF are incorporated in North Carolina, and DSSVA is
incorporated in Virginia and, as C corporations, file their federal income tax
returns as part of a consolidated group. Prior to the initial public offering,
DSS and RPM filed their federal income tax returns as part of THE's consolidated
group. An income tax benefit has been recorded in 1996 and 1997 since the losses
of DSS and RPM were applied to income in THE's consolidated group. DSS, RPM and
DSSF file separate state returns since state income tax regulations do not
permit filing consolidated returns.

RESULTS OF OPERATIONS

          The Year Ended December 31, 1998 Compared to the Year Ended December
31, 1997

INCOME

          Total income increased $1,125,105, to $3,644,157 for the year ended
December 31, 1997 from $2,519,052 for year ended December 31, 1997. The
increases were primarily due to development fees recognized in 1998 and an
increase in home care income, while management fees and reimbursement income
decreased.

          MANAGEMENT FEES. Management fees decreased $87,600 to $770,999 for
1998 from $858,599 for the year ended December 31, 1997. The Company stopped
managing two large non-elderly apartment properties that did not fit into the
long term goals of the Company. Management fees from these properties were
included in 1997 fees, but not in 1998 fees. On July 31, 1998 the Company sold
the management rights for 361 units, primarily multi-family, which generated
management fees of approximately $10,500 per month. The Company expects growth
in fee income as it begins to manage properties currently in development.

          REIMBURSEMENT INCOME. Reimbursement income decreased $75,371 to
$1,379,598 for 1998 from $1,454,969 for the year ended December 31, 1997. The
decrease was primarily the result of having fewer employees and fewer sites. The
Company no longer managed the two large, non-elderly sites in 1998 and,
beginning July 31, 1998, the 361 units whose management rights were sold.
Offsetting the effect of the decrease was reimbursement

                                       11

<PAGE>

income received from the management of the assisted living facility in Virginia
during the fourth quarter. The Company expects increases in reimbursement income
as the number of properties under management increases.

          DEVELOPMENT FEES. Development fees of $1,135,779 were recognized for
the year ended December 31, 1998. The income represents 60% of the total
estimated development fees of five 60-unit facilities and two 30-unit residences
with construction starts during the second, third and fourth quarters.
Development fees also include 20% of the total estimated development fee of one
60-unit facility for which the land has been acquired. The Company expects
development fee income to increase as the 60-unit and 30-unit properties begin
to roll out.

          HOME CARE FEES. Home care fees increased $142,587 to $328,469 for 1998
from $185,882 for 1997. The Company increased the hours charged by increasing
the number of individuals served. The Company provides care for residents of the
apartments for the elderly managed by the Company and for others. The Company
expects moderate growth over time in home care fees.

OPERATING EXPENSES

          Operating expenses increased $399,437 to $3,822,542 for the year ended
December 31, 1998 from $3,423,105 for the year ended December 31, 1997.
Personnel related expenses decreased, while administrative expenses increased;
the net change was an increase.

          PERSONNEL EXPENSE. Personnel expense decreased $22,269 to $2,880,996
for 1998 from $2,903,265 for 1997. Site related personnel expense decreased
$75,371 for the year due to having fewer employees on site and no longer
managing the two non-elderly apartment sites and the 361 units whose management
rights were sold July 31, 1998, offset by the increase in personnel expense at
the Virginia facility, mentioned above. There were increases in both the number
of corporate personnel and their rate of pay in 1998 compared to 1997. The
Company expects increases in personnel expense in future periods due to
increased management activity.

          ADMINISTRATION AND OTHER EXPENSES. Administration and other expenses
increased $414,519 to $871,253 in 1998 from $456,734 in 1997. The increases
reflect increased activity in home care, the assisted living development
activity, and expenses related to operating the public company. The Company
expects further increases in administrative expenses as the number of assisted
living properties managed increases.

          DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense increased $7,187 to $70,293 in 1998 from $63,106 in 1997. The Company
expects modest increases in depreciation expense due to the purchase of office
furniture and equipment used by management personnel.

          OTHER INCOME AND EXPENSES. Interest expense of $5,678 and $134,536 was
incurred for the years ended December 31, 1998 and 1997, respectively. The
interest expense was incurred on a bank loan, which was paid off with proceeds
from the equity offering completed in January 1998. The Company earned $166,268
in interest income from cash and cash equivalents during the year ended December
31, 1998, and had an unrealized gain of $16,061 on funds held for development.

          INCOME TAX BENEFIT. The Company did not record an income tax benefit
for the year ended December 31, 1998 since the losses of the Company can only be
carried forward and applied to future income of the Company. For the year ended
December 31, 1997, the Company recorded a tax benefit of $269,900 since the
losses of the Company and its subsidiary were used to reduce prior period income
of THE and its consolidated group. Due to the public company status of the
Company, the Company and its subsidiaries were no longer consolidated with THE
for federal income tax purposes effective January 14, 1998.

          NET LOSS. The net loss decreased $750,894 to $17,795 ($.01 per share)
for the year ended December 31, 1998 from $768,689 ($.38 per share) for the year
ended December 31, 1997. The decrease was due to the net effect of a decrease in
operating loss of $725,668, an increase in interest income of $166,268, a
decrease in interest expense of $128,858 and a decrease in the income tax
benefit of $269,900 as described above.

                                       12


<PAGE>

FINANCIAL CONDITION

DECEMBER 31, 1998 COMPARED TO DECEMBER 31, 1997

          The Company had current assets of $1,056,003 on December 31, 1998 and
$643,311 on December 31, 1997. The primary current asset on December 31, 1997
was offering expenses of $425,821, which were incurred to prepare for the
offering of 1,500,000 shares of common stock completed during the quarter ended
March 31, 1998. After the completion of the offering, these expenses were
charged to equity. Also following the completion of the offering, the Company
had approximately $3.5 million to use in the development activity. On December
31, 1998 the balance was reduced to $819,074 due to the Company's increased
development activity. Accounts receivable increased from $92,878 to $113,921 due
to increased activity in home care and prepaid expenses increased from $12,280
to $90,858 due primarily to the payment of directors and officers insurance
premiums. The Company expects receivables to increase as the Company increases
management of apartment units and assisted living residences.

          Furniture and equipment net of depreciation increased to $90,201 from
$56,487 due to purchases of computer equipment for corporate personnel of
$86,095. Depreciation expense for the year ended December 31, 1998 was $52,381.
Intangible assets net of amortization decreased from $114,779 to $43,235 due to
the July 31, 1998 sale of management rights and amortization expense. Other
assets decreased from $114,779 to $43,235 due to the July 31, 1998 sale of
management rights.

          Development costs increased to $730,604 at December 31, 1998 from
$241,433 at December 31, 1997 due to continuing development activities with
respect to assisted living residences and residences with services. Development
costs will either be recouped with the successful completion of a property or
written off if a site is abandoned.

          Development fees and costs due from properties currently held by THE
was $2,603,656 at December 31, 1998. The increase is due to development fees and
reimbursable costs on properties currently being developed owed to the Company.

         Accounts receivable-affiliates increased to $489,669 at December 31,
1998 from $310,407 at December 31, 1997. The increase is the net effect of
transactions between DSS and the majority stockholder, including the tax benefit
to THE's operating losses in 1997.

          Total liabilities decreased $2,670,461 to $431,542 at December 31,
1998 from $3,102,003 at December 31, 1997. Accounts payable and accrued expenses
decreased to $239,719 from $652,445 primarily due to the payment of offering
expenses that were accrued at December 31, 1997. The bank loan and accrued
interest were paid off during the quarter ended March 31, 1998 and the deferred
salaries of $577,508 and deferred bonuses of $42,582 were also paid off during
the first six months. Proceeds from the equity offering provided the funds to
pay the liabilities referred to above.

          Shareholder's equity increased to $4,581,826 at December 31, 1998 from
a deficit of $1,735,586 at December 31, 1997. The increase was the net effect of
the increase in common stock net of issue costs of $6,319,146, an unrealized
gain on investment securities of $16,061 and a $17,795 increase in accumulated
deficit.

LIQUIDITY AND CAPITAL RESOURCES

          The Company has operated, and expects to continue to operate, on a
negative cash flow basis due to start-up expenses and length of the development
cycle. Currently, the Company's primary cash requirements include covering
operating deficits and development expenses related to the development,
construction and fill-up of 60-unit assisted living residences and 30-unit
independent senior housing residences with services. The Company had relied upon
its parent, THE, and its bank to provide it with operating cash until the
initial public offering was completed January 14, 1998. After January 14, 1998,
the Company has not relied upon, nor does it expect to rely upon, THE for
assistance in bank financings.

         The net proceeds of the public offering were used to pay off the
outstanding balance under the bank line of credit, to provide $3.5 million in
development working capital for the assisted living projects and for general

                                       13


<PAGE>

corporate purposes. The Company anticipates that the net proceeds from the
public offering, together with construction funds available for each facility
will be insufficient to fund its operations for the next twelve months, and that
the Company's current development plans will require additional debt or equity
financing during the second quarter of 1999. The Company currently has several
sources of potential funding and does not anticipate that liquidity demands will
not be met. There can be no assurance that the Company will be able to obtain
financing on a favorable or timely basis. The type, timing and terms of
financing selected by the Company will depend on its cash needs, the
availability of other financing sources and the prevailing conditions in the
financial markets.

          The Company is the guarantor on the construction loans for the
properties currently under construction owned by THE.

INFLATION AND INTEREST RATES

          Inflation has minimal impact on the daily operations of the Company.
Increases in salaries and administrative expenses are offset by increases in
management fees that are computed as a percentage of rent and resident service
fees. Increases in resident service fees may lag behind inflation since the
amount of the fee is based on a cost reimbursement by public sources. Except for
the lag time, however, the Company expects the reimbursement to keep pace with
inflation.

          The primary concern regarding inflation is in interest rate
fluctuations. High interest rates would increase the cost of building new
facilities and could slow down the Company's development plans. Also, during a
period of rapid inflation, interest rates could become so expensive that it
would not be economical to use tax exempt bond financing for permanent
financing.

YEAR 2000

          Many currently installed computer systems and software are coded to
accept only two digit entries in the date code filed. Beginning the year 2000,
these date code fields will need to accept four digit entries to distinguish
twenty-first century dates from twentieth century dates. As a result, within the
next eighteen months, computer systems and/or software used by many companies
may need to be upgraded to comply with such "Year 2000" requirements.

          The Company has developed plans to modify its computer information
systems enabling proper processing of data relating to the year 2000 and beyond.
The Company has been informed by Electronic Data System ("EDS"), the paying
agent for the North Carolina Medicaid program, that the National Electronic
Claims Submission ("NECS") software developed by EDS for electronic claims
submission by North Carolina Medicaid providers, is not currently Year 2000
compliant. Compliance is anticipated by September 1999. Medicaid revenues do not
currently constitute a material portion of the Company's revenues; but as
additional assisted living residences are added to the Company's management
portfolio, the Medicaid revenues will increase. All other computer programs
currently in use by the Company have been upgraded to be Year 2000 compliant.

          While there can be no assurance that Year 2000 matters will be
satisfactorily identified and resolved, the Company currently believes that Year
2000 issues will not have a material adverse effect on the Company. The
possibility exists that isolated incidents of a Year 2000 nature could affect
individual properties managed by the Company, but the Company does not
anticipate that such incident(s) would have a material impact on the Company's
business or operations. The Company is in the process of contacting customers,
vendors and service providers to determine which of them is affected by the year
2000 problem, and to what extent, in order to assess the potential impact on the
Company.



CERTAIN ACCOUNTING CONSIDERATIONS

SFAS NO. 123

          In October 1995, FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). SFAS No. 123 establishes financial accounting
and reporting standards for stock-based employee compensation plans. Those plans
include all arrangements by which employees receive shares of stock or other
equity instruments of the employer or the employer incurs liabilities to
employees in amounts based on the price of

                                       14


<PAGE>

the employer's stock. Examples are stock purchase plans, stock options,
restricted stock awards, and stock appreciation rights. This statement also
applies to transactions in which an entity issues its equity instruments to
acquire goods or services from non-employees. Those transactions must be
accounted for, or at least disclosed in the case of stock options, based on the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measurable. The accounting
requirements of SFAS No. 123 are effective for financial statements for fiscal
years beginning after December 15, 1995, or for an earlier fiscal year for which
SFAS No. 123 is initially adopted for recognizing compensation cost. The
statement permits a company to choose either a new fair value-based method or
the current APB Opinion No. 25 intrinsic value-based method of accounting for
its stock-based compensation arrangements. The Company adopted its Stock
Incentive Plan effective January 1, 1997. During 1998, the Company granted
47,000 stock options at an exercise price ranging from $4.75 to $5.225, the
market value of the shares at the date of grant. The stock options are 100%
vested and have a five-year term. Warrants for 45,000 shares were issued with a
four-year term, a one-year vesting schedule and exercise prices ranging from
$6.00 to $9.00 per share. Warrants for 50,000 shares have a four-year term, one
year vesting schedule and an exercise price of $6.75 per share. At December 31,
1998, a total of 142,000 stock options and warrants are outstanding, 1,400
common shares have been issued and 356,600 shares are available for granting. At
December 31, 1997, no grants had been made.



ITEM 7. FINANCIAL STATEMENTS.

          Reference is made to the Financial Statements, the reports thereon and
the notes thereto, commencing on page F-1 of this report.


ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

         None.



                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(A) OF THE EXCHANGE ACT.

ITEM 10. EXECUTIVE COMPENSATION.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

          Part III information will be set forth in the Company's definitive
proxy statement for the Company's 1999 Annual Meeting of Stockholders.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.

         (a)      Exhibits:

EXHIBIT NO.             DESCRIPTION

     3.1       Articles of Incorporation of the Company (as amended).
               Incorporated by reference to Exhibit 3.1 to Registration
               Statement on Form SB-2 (File No. 333-34367).

     3.1(a)    Articles of Amendment filed October 6, 1997. Incorporated by
               reference to Exhibit 3.1(a) to Registration Statement on Form
               SB-2 (File No. 333-34367).

                                       15
<PAGE>

     3.1(b)    Articles of Amendment filed March 19, 1999 incorporating
               Certificate of Designation, Powers, Preferences and Rights of the
               Series of Preferred Stock of Diversified Senior Services, Inc. to
               be designated 12% Series B Cumulative Convertible Preferred
               Stock.

     3.2       Bylaws of the Company, as amended. Incorporated by reference to
               Exhibit 3.2 to Registration Statement on Form SB-2 (File No.
               333-34367).

     10.1      Employment Agreement dated as of January 1, 1997 between the
               Company and William G. Benton, as amended. Incorporated by
               reference to Exhibit 10.1 to Registration Statement on Form SB-2
               (File No. 333-34367).

     10.2      Employment Agreement dated as of January 1, 1997 between the
               Company and Susan L. Christiansen, as amended. Incorporated by
               reference to Exhibit 10.2 to Registration Statement on Form SB-2
               (File No. 333-34367).

     10.3      Employment Agreement dated as of January 1, 1997 between the
               Company and G. L. Clark, Jr., as amended. Incorporated by
               reference to Exhibit 10.3 to Registration Statement on Form SB-2
               (File No. 333-34367).

     10.4      Lock-up agreements. Incorporated by reference to Exhibit 10.4 to
               Registration Statement on Form SB-2 (File No. 333-34367).

     10.5      The Company's 1997 Stock Incentive Plan. Incorporated by
               reference to Exhibit 10.5 to Registration Statement on Form SB-2
               (File No. 333-34367).

     10.6      Employment Agreement dated as of February 1, 1998 between the
               Company and Bernard Gawley.

     20        Independent Auditors' Report.

     21        Subsidiaries of the Company

     23        Consent of The Daniel Professional Group, Inc.

     24        Powers of Attorney

     27        Financial Data Schedule.

               (b)  Reports  on Form 8-K.

                    None:

                                       16
<PAGE>
                                   SIGNATURES

          In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

                                  DIVERSIFIED SENIOR SERVICES, INC.


                                  By:  /S/ WILLIAM G. BENTON
                                       William G. Benton, Chairman of the Board
                                       and Chief Executive Officer
                                  Date: MARCH 30, 1999


          In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.


   SIGNATURE                          TITLE                         DATE

/s/ WILLIAM G. BENSON         Chairman of the Board and         March 30, 1999
---------------------------   Chief Executive Officer
William G. Benson

/s/ SUSAN L. CHRISTIANSEN     Chief Operating Officer           March 30, 1999
---------------------------   and Director
Susan L. Christiansen

/s/ G.L. CLARK, JR.           Chief Financial Officer,          March 30, 1999
---------------------------   Treasurer and Director
G.L. Clark, Jr.

/S/ SUSAN L. CHRISTIANSEN     Director                          March 30, 1999
---------------------------
Susan L. Christiansen
Attorney in Fact for
Perry C. Craven

/S/ SUSAN L. CHRISTIANSEN     Director                          March 30, 1999
---------------------------
Attorney in Fact for
Walter H. Ettinger, Jr.

                                       17
<PAGE>
                          INDEPENDENT AUDITORS' REPORT




To the Board of Directors and Shareholders of
   Diversified Senior Services, Inc. and Subsidiaries


     We have audited the accompanying consolidated balance sheets of Diversified
Senior Services, Inc. and Subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of operations, changes in shareholder's deficit,
and of cash flows for the years ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.

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

     As described in Note 5, the Company completed its initial public offering
on January 14, 1998.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Diversified Senior Services, Inc. and Subsidiaries as of December 31, 1998 and
1997 and the consolidated results of its operations and cash flows for the years
then ended in conformity with generally accepted accounting principles.



February 19, 1999
Winston-Salem, North Carolina
                                      F-1
<PAGE>
                       DIVERSIFIED SENIOR SERVICES, INC.
                          CONSOLIDATED BALANCE SHEETS



<TABLE>
<CAPTION>
                                                                    December 31,       December 31,
                                                                         1998              1997

ASSETS
Current assets:
<S>                                                                  <C>                  <C>
        Cash and cash equivalents                                    $32,150              $78,156
        Investments held for development (Note 7)                    819,074                 -
        Accounts receivable--trade                                   113,921               92,878
        Offering expenses                                               -                 425,821
        Prepaid expenses and other                                    90,858               46,456
                                                                   1,056,003              643,311

Furniture and equipment, net (Note 3)                                 90,201               56,487
Development costs                                                    730,604              241,433
Development fees and costs due from affiliates (Note 2)            2,603,656                 -
Accounts receivable--affiliates (Note 2)                             489,669              310,407
Other assets                                                          43,235              114,779
                                                                      ------              -------

                                                                  $5,013,368           $1,366,417
                                                                  ==========           ==========

       LIABILITIES
Current liabilities:
        Accounts payable and accrued expenses                       $239,719             $652,445
        Note payable--bank (Note 4)                                     -               1,637,645
        Deferred salaries and bonuses                                191,823              811,913
                                                                     -------              -------
                                                                     431,542            3,102,003
                                                                     -------            ---------

       SHAREHOLDERS' EQUITY (DEFICIT)
Preferred stock, no par, authorized 100,000,000 shares;
        178,386 issued and outstanding at December 31,
        1998 and 1997                                                891,930              891,930
Common stock, no par, authorized 100,000,000 shares;
        3,301,400 shares issued and outstanding at
        December 31, 1998 and 1,800,000 at December 31, 1997       6,319,246                  100
Unrealized gains on investments (Note 7)                              16,061                 -
Deemed distribution                                               (1,335,790)          (1,335,790)
Accumulated deficit                                               (1,309,621)          (1,291,826)
                                                                  ----------           ----------
                                                                   4,581,826           (1,735,586)
                                                                   ---------           ----------
                                                                  $5,013,368           $1,366,417
                                                                  ==========           ==========

    The accompanying notes are an integral part of the financial statements.
</TABLE>
                                      F-2
<PAGE>
                        DIVERSIFIED SENIOR SERVICES, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS

                 For the Years ended December 31, 1998 and 1997





<TABLE>
<CAPTION>
                                                                           1998                  1997

Income:
<S>                                                                      <C>                   <C>     
        Management fees (Note 2)                                         $770,999              $858,599
        Reimbursement income (Note 2)                                   1,379,598             1,454,969
        Development fees (Note 2)                                       1,135,779                  -
        Home care fees                                                    328,469               185,882
        Other                                                              29,312                19,602
                                                                        ---------             ---------
                                                                        3,644,157             2,519,052
                                                                        ---------             ---------

Expenses:
        Personnel related                                               2,880,996             2,903,265
        Administrative and other                                          871,253               456,734
        Depreciation and amortization                                      70,293                63,106
                                                                        ---------             ---------
                                                                        3,822,542             3,423,105

Operating loss                                                            178,385               904,053
Other (income) expenses:
        Interest and other income                                        (166,268)                 -
        Interest expense and other                                          5,678               134,536
                                                                        ---------             ---------
Loss before income tax benefit                                             17,795             1,038,589
        Income tax benefit (Note 10)                                         -                 (269,900)
                                                                        ---------             ---------

Net loss                                                                  $17,795              $768,689
                                                                        =========             =========
Net loss per common share                                                   $0.01                 $0.38
                                                                        =========             =========
Weighted average shares outstanding                                     3,246,940             2,036,926
                                                                        =========             =========


    The accompanying notes are an integral part of the financial statements.

</TABLE>
                                      F-3
<PAGE>
                        DIVERSIFIED SENIOR SERVICES, INC.
             STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)

                 For the Years Ended December 31, 1998 and 1997




<TABLE>
<CAPTION>
                                                                                 Unrealized
                                    Preferred   Common    Preferred    Common      Gain on      Deemed       Accumulated
                                     Shares     Shares      Stock       Stock    Investments  Distribution     Deficit     Total

<S>                                  <C>       <C>        <C>          <C>        <C>         <C>            <C>        <C>
Balance, January 1, 1997               -       2,277,778  $   -            $100   $  -        $(1,335,790)   $(523,137) $(1,858,827)
Retirement of common stock,
   June 30, 1997                       -        (477,778)     -           -          -               -            -            -
Exchange note payable to affiliate
   for preferred stock              178,386         -       891,930       -          -               -            -         891,930
Net loss for the year ended
   December 31, 1997                   -            -         -           -          -               -        (768,689)    (768,689)
                                   --------    ---------   --------   ---------   -------     ------------ ------------ -----------
Balance, December 31, 1997          178,386    1,800,000   $891,930        $100   $  -        $(1,335,790) $(1,291,826) $(1,735,586)
                                   --------    ---------   --------   ---------   -------     ------------ ------------ -----------

Issuance of common stock               -       1,501,400      -       6,319,146      -               -            -       6,319,146
Unrealized gains on investments        -            -         -           -        16,061            -            -          16,061
Net loss for the year ended
   December 31, 1998                   -            -         -           -          -               -         (17,795)     (17,795)
                                   --------    ---------   --------   ---------   -------     ------------ ------------ -----------
Balance, December 31, 1998          178,386    3,301,400   $891,930  $6,319,246   $16,061     $(1,335,790) $(1,309,621) $4,581,826
                                    =======    =========   ========  ==========   =======     ===========  ===========  ==========


    The accompanying notes are an integral part of the financial statements.

</TABLE>
                                      F-4
<PAGE>
                       DIVERSIFIED SENIOR SERVICES, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                 For the Years ended December 31, 1998 and 1997

                Increase (Decrease) in Cash and Cash Equivalents


<TABLE>
<CAPTION>
                                                                             1998                   1997

Operating activities:
<S>                                                                        <C>                   <C>       
Net loss                                                                   $(17,795)             $(768,689)
Adjustments to reconcile net loss to net cash
  used by operating activities:
        Depreciation and amortization                                        70,293                63,106
        Gain on sale of management contracts                                 (7,700)                 -
        Changes in operating assets and liabilities:
            Accounts receivable                                             (21,043)                5,521
            Accounts receivable, affiliates                                 (25,525)                 -
            Development fees receivable                                  (1,135,779)                 -
            Prepaid expenses                                                (17,870)                6,588
            Accounts payable, trade                                          25,066                52,452
            Accounts payable, affiliates                                     38,411              (215,776)
            Interest payable                                                (33,070)               26,483
            Deferred salaries and bonuses                                  (620,090)              383,625
                                                                         ----------              -------- 
                  Total adjustments                                      (1,727,307)              321,999
                                                                         ----------              -------- 
        Net cash used by operating activities                            (1,745,102)             (446,690)
                                                                         ----------              -------- 

Investing activities:
        Increase in investments held for development                       (803,013)                 -
        Purchase of furniture and equipment                                 (84,848)               (4,994)
        Development costs paid                                             (456,584)             (104,256)
        Advances to affiliate for properties in development              (1,467,877)                 -
        Sale of management contracts                                         61,851                  -
        Other                                                               (50,520)               35,250
                                                                         ----------              -------- 
        Net cash used by investing activities                            (2,800,991)              (74,000)
                                                                         ----------              -------- 

Financing activities:
        (Repayment of) proceeds from borrowings                          (1,729,575)              797,953
        Proceeds from issuance of common stock, net                       6,446,810                  -
        Offering expenses prepaid                                              -                 (127,664)
        Advances (to) and repayments from affiliates                       (192,148)             (101,575)
        Other                                                               (25,000)               (1,000)
                                                                         ----------              -------- 
        Net cash provided by financing activities                         4,500,087               567,714
                                                                         ----------              -------- 

Net increase (decrease) in cash                                             (46,006)               47,024
Cash and cash equivalents - beginning                                        78,156                31,132
                                                                         ----------              -------- 
Cash and cash equivalents - ending                                          $32,150               $78,156
                                                                         ==========              =========
Cash payments for interest                                                  $38,748               $80,861
                                                                         ==========              =========

For supplemental schedule of non-cash investing and financing activities, see Note 2.


    The accompanying notes are an integral part of the financial statements.

</TABLE>
                                      F-5
<PAGE>

                        Diversified Senior Services, Inc.
                   Notes to Consolidated Financial Statements
                                December 31, 1998



NOTE 1:  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Diversified Senior Services, Inc. (the "Company"), a North Carolina corporation
is a public company listed on Nasdaq Small Cap market. It is a growth company
focused on the development, acquisition and management of apartments,
independent living apartments with services and assisted living residences for
low and moderate-income seniors. The development, acquisition and management
services are performed for both related and unrelated third party property
owners. The Company currently operates in the Midatlantic and Southeast sections
of the country. It was founded as a wholly-owned subsidiary of Taylor House
Enterprises ("THE") on May 17, 1996. On January 14, 1998, the Company completed
its initial public offering when it issued 1,500,000 shares of common stock,
which is described in Note 6.

The Company formed a wholly-owned subsidiary, DSS Funding, Inc. ("DSSF"), a
North Carolina corporation, on February 16, 1998, for the purpose of securing
permanent financing for the assisted living facilities and senior residences
which the Company develops or acquires for third party owners. On July 22, 1998,
the Company formed a wholly-owned subsidiary; Diversified Senior Services of
Virginia, Inc. ("DSSVA"), a Virginia corporation, for the purpose of conducting
development and management of properties in Virginia.

The following significant accounting policies have been followed in the
preparation of the Company's financial statements.

CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
     and its wholly-owned subsidiaries, Residential Properties Management, Inc.
     ("RPM"), DSSF and DSSVA. All significant intercompany transactions have
     been eliminated in consolidation.

CASH EQUIVALENTS

     For purposes of the statement of cash flows, the Company considers all
     highly liquid investments purchased within three months of maturity to be
     cash equivalents.

INVESTMENTS HELD FOR DEVELOPMENT

     The Company's investments held for development are classified as
     available-for-sale securities and are reported at fair value, with
     unrealized gains and losses excluded from earnings and reported in a
     separate component of shareholders' equity.

ACCOUNTS RECEIVABLE - TRADE

     Accounts receivable - trade consists of management fees and reimbursements
     for administrative services due from partnerships and other entities whose
     properties are managed by RPM, and home care revenues which are due
     primarily from Medicaid. The Company and its subsidiaries provide services
     to customers and clients on a noncollateralized basis.

FURNITURE AND EQUIPMENT

     Furniture and equipment are stated at cost. Depreciation is determined
     using the straight line method and is based on the estimated useful lives
     of the related assets of three to five years. Expenditures for maintenance
     and repairs which do not improve or extend the life of an asset are
     expensed as incurred. Major renewals and betterments are charged to the
     property accounts. Upon retirement or sale of an asset, its cost and
     related accumulated depreciation are removed from the property accounts and
     any gain or loss is recorded as income or expense.

DEVELOPMENT COSTS

     Development costs are expenses, including certain salaries, which are
     capitalized during the development of new facilities. The properties are
     developed for third party owners and the costs are reimbursed based upon
     the terms of the financing arrangements. Costs for abandoned sites are
     written off when the sites are considered not feasible.

                                      F-6
<PAGE>

NOTE 1:  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED


NET INCOME (LOSS) PER SHARE

     Net income (loss) per share is computed based on the weighted average
     number of common shares outstanding for the period.

ESTIMATES AND ASSUMPTIONS

     The preparation of financial statements in conformity with generally
     accepted accounting principles (GAAP) requires management to make estimates
     and assumptions that affect the reported amounts of assets and liabilities
     and disclosure of contingent assets and liabilities at the date of the
     financial statements and the reported amounts of income and expenses during
     the reporting period. Actual results could differ from those estimates.

INCOME TAXES

     The Company is a C corporation and prior to the initial public offering,
     filed its federal income tax return as a part of a consolidated group with
     THE. Tax expense or benefit is allocated based on net income or loss for
     each entity in the consolidated group. As a result of the initial public
     offering, the Company no longer is included in the consolidated group with
     THE for federal income tax purposes effective January 14, 1998. The Company
     and its subsidiaries will file a separate consolidated federal income tax
     return from THE.

     State income tax regulations generally do not permit filing of consolidated
     income tax returns. Accordingly, the Company and its subsidiary file
     separate state corporate income tax returns as described further in Note
     10.

     The Company uses the asset and liability approach for financial accounting
     and reporting for income taxes and deferred tax assets and liabilities. If
     it is more likely than not that some portion or all of a deferred tax asset
     will not be realized, a valuation allowance is recognized.

INCOME RECOGNITION

     Management fee income is assessed as a percentage of rent collected at the
     properties. Income is recognized monthly as rent is collected.

     Reimbursement income consists of amounts charged to the properties managed
     for the services of management and maintenance personnel employed by the
     Company.

     Development fee income is recognized on the percentage of completion basis.

     Home care revenues are recognized at the time the service is provided. A
     significant portion of the Company's home care revenues are reimbursed by
     the Medicaid PCS program.

PREFERRED STOCK

     The Company's Articles of Incorporation provide authority for the issuance
     of 100,000,000 shares of preferred stock, no par value. On September 24,
     1997, the Board of Directors classified a series of 200,000 shares of
     convertible, preferred stock as Series A preferred stock. The Series A
     preferred stock is nonvoting, is subordinate to the common stock for
     payment of dividends, has a stated liquidation value of $5 per share which
     is subordinate to a preferred distribution to holders of common stock equal
     to $10 per share, may be converted to common stock at $6 per share after
     September 30, 1999 and is not redeemable at the option of the holder.
     Attributes or preferences have not been established for the remaining
     unissued stock.

STOCK OPTIONS

     The Company has adopted APB Opinion No. 25 intrinsic value based method of
     accounting for its stock-based compensation arrangements. The difference
     between the option price and the price of the stock at the date of the
     grant is recorded as compensation expense.

RECLASSIFICATION

     Certain items in the financial statements for 1997 have been reclassified
     to conform to the format presented in these financial statements.

                                      F-7

<PAGE>

NOTE 2:  RELATED PARTY TRANSACTIONS

The Company is developing six properties for 60-unit assisted living facilities
and two 30-unit independent senior housing residences with services. Five of the
60-unit and the two 30-unit projects are currently under construction. The owner
of the properties is THE, the majority stockholder of the Company. THE intends
to sell the 60-unit properties to a not for profit owner after permanent
financing is completed. At December 31, 1998 development fees of $1,135,779 and
reimbursable costs of $1,467,877 are due to the Company from THE. The Company is
the guarantor on the construction loans for the properties currently under
construction. The amount of the loans outstanding at December 31, 1998 was
$890,598. The total commitment for the properties currently under construction
is $7,150,000.

RPM leases certain computer equipment from THE under operating lease agreements
expiring in 2003. These lease agreements are included in the lease information
disclosed in Note 11.

From time to time, the Company advances or borrows funds from THE or other
related entities.

On September 30, 1997, the Company, in a non-cash transaction, issued 178,386
shares of preferred stock to THE in exchange for a note payable to THE in the
amount of $891,930. The remaining amount of $76,554 was reclassified to an
account payable. The interest rate on this note was 8.25% per annum and interest
expense of $27,191 was accrued for the nine months ended September 30, 1997.

The following schedule summarizes the related party activities for the years
ended December 31, 1998 and December 31, 1997.

<TABLE>
<CAPTION>
                                                         Due from       Due (to) from          Note
                                                        Affiliated        THE  and            Payable
                                                       PARTNERSHIPS     SUBSIDIARIES            THE             TOTAL

<S>                                                    <C>              <C>                 <C>              <C>        
Amounts due (to) from affiliates at January 1, 1997:   $   233,616      $   (36,170)        $ (1,096,320)    $ (898,874)
    Repayment to affiliate                                    -              33,415               -             33,415
    Computer equipment lease
       payment due to THE                                     -              (5,333)              -             (5,333)
    Rent due to THE                                                         (21,600)                           (21,600)
    Accrued interest to THE                                                 (27,191)                           (27,191)
    Repayments to THE                                         -              90,771              127,836       218,607
    Advances from THE                                         -            (150,447)              -           (150,447)
    Exchange note for preferred stock                         -                -                 891,930       891,930
    Reclassify remaining note to
       account payable                                        -             (76,554)              76,554          -
Tax benefit of operating losses
       due from THE                                           -             269,900               -            269,900
                                                       -----------       -----------          -----------       -----------
Balance, December 31, 1997                                 233,616           76,791               -            310,407

    Computer equipment lease
       payment due to THE                                     -              (6,011)              -             (6,011)
    Rent due to THE                                           -             (32,400)              -            (32,400)
    Development fees and costs due
       from properties currently held by THE                  -           2,603,656               -          2,603,656
    Advances due from affiliate                                             142,705                            142,705
    Repayments to THE                                         -             277,242                            277,242
    Advances from THE                                         -            (202,274)              -           (202,274)
                                                       -----------       ------------     ----------        ------------

Balance, December 31, 1998                             $   233,616      $ 2,859,709      $        -        $ 3,093,325
                                                       ===========       ===========      ===========       ===========

</TABLE>
                                      F-8
<PAGE>


                        Diversified Senior Services, Inc.
             Notes to Consolidated Financial Statements - Continued



NOTE 2:  RELATED PARTY TRANSACTIONS - CONTINUED

There was no interest income received from related parties during the years
ended December 31, 1998 and 1997. The amounts due from affiliated partnerships
are collectible, but will not be realized until such time as certain
partnerships terminate. The Company earned income from a subsidiary of THE and
partnerships, a general partner of which is a beneficial shareholder of THE, for
the years ended December 31, 1998 and 1997 as follows:

                                              1998                 1997

     Management fees                   $      293,753       $     288,385
     Reimbursement fees                       591,450             550,946
     Home care fees                            12,480               9,360
                                       --------------       -------------
                                       $      897,683       $     848,691
                                       ==============       =============

At December 31, 1998 and 1997, $26,431and $26,237, respectively, of such fees
are included in trade accounts receivable and $25,525 is included in accounts
receivable-affiliates at December 31, 1998.



NOTE 3:  FURNITURE AND EQUIPMENT

The Company has furniture and equipment as follows:

                                                  1998                  1997
                                                  ----                  ----

     Computer equipment                    $      163,557        $      86,355
     Office furniture                              52,005               43,112
                                           --------------        -------------
                                                  215,562              129,467
-----
Less accumulated depreciation                     125,361               72,980
                                           --------------        -------------
                                           $       90,201        $      56,487
                                           ==============        =============


Depreciation expense for the years ended December 31, 1998 and 1997 was $52,381
and $36,958, respectively.


NOTE 4:

NOTES PAYABLE

On December 31, 1997 the Company had a bank line of credit bearing interest at
prime (8.50% at December 31, 1997), with a balance of $1,604,575 and accrued
interest of $33,070. The note and accrued interest were paid on January 14,
1998.

<PAGE>
                        Diversified Senior Services, Inc.
             Notes to Consolidated Financial Statements - Continued


NOTE 5: INITIAL PUBLIC OFFERING

On January 14, 1998 the Company completed its public offering of 1,500,000
shares of common stock at $5.00 per share. The following gives the effect of the
offering and subsequent use of the proceeds.

    Gross proceeds (1,500,000 shares at $5.00 per share)    $        7,500,000
    Offering expenses paid during 1998                              (1,057,350)
                                                             ------------------
                                                                     6,442,650
    Offering expenses paid prior to December 31, 1997                 (127,664)
                                                              -----------------
    Net proceeds from offering                                       6,314,986
                                                              -----------------

    Use of proceeds:
        Repayment of bank loan and accrued interest                 (1,637,645)
        Payment of deferred salaries and bonuses                      (620,090)
        Investments held for development                            (3,500,000)
                                                                    (5,757,735)
    Remainder to be used for general corporate purposes        $       557,251
                                                                ===============

                                      F-9
<PAGE>

NOTE 6:  FINANCIAL INSTRUMENTS

The Company's financial instruments include cash, investments, note payable to a
bank and amounts due to and from affiliates. At December 31, 1998 and 1997, the
carrying values of cash, investments and the note payable approximated their
fair values based on current market prices and rates. It was not practicable to
estimate the fair value of the amounts due to and from affiliates as the
repayment terms have not been established and they are non-interest bearing.


NOTE 7:  INVESTMENTS HELD FOR DEVELOPMENT

The Company's investments held for development are invested in government and
corporate bond mutual funds and are held for development and construction of
assisted living facilities. These investments are classified as available for
sale and accordingly, unrealized gains of $16,061 at December 31, 1998 have been
recorded in equity. The carrying value of the funds were based on current market
prices at the statement date. Proceeds from sales of the company's investments
for the year ended December 31, 1998 were $2,990,065 resulting in realized gains
of $52,328 and realized losses of $51,797. These gains and losses are reflected
under other income in the financial statements.


NOTE 8:  SAVINGS INCENTIVE PLAN

The Company participates in a defined contribution savings incentive plan
covering substantially all of its full time employees. The Company provided a
50% matching contribution to each employee participant for contributions up to
the first 5% of compensation. On January 1, 1996, the plan was amended to cover
substantially all employees of the controlled group of companies owned by THE.
The Company's contribution for the years ended December 31, 1998 and 1997 was
$33,595 and $21,465, respectively.


NOTE 9:  STOCK INCENTIVE PLAN

Effective January 1, 1997, the Directors and shareholder adopted the Company's
1997 Stock Incentive Plan for 500,000 shares of common stock, which authorizes
the Board (or future committee) to issue stock options, stock appreciation
rights, restricted stock and deferred stock subject to the Plan and such other
terms as set by the board. The Company granted 47,000 stock options to certain
employees at an exercise price ranging from $4.75 to $5.225, the market value of
the shares at the date of grant. The stock options are 100% vested and have a
five-year term. Warrants for 45,000 shares were issued with a four-year term, a
one-year vesting schedule and exercise prices ranging from $6.00 to $9.00 per
share. Warrants for 50,000 shares have a four-year term, one year vesting
schedule and an exercise price of $6.75 per share. All the warrants were issued
to third parties for services rendered. At December 31, 1998, a total of 142,000
stock options and warrants are outstanding, 1,400 common shares have been issued
and 356,600 shares are available for granting. At December 31, 1997, no grants
had been made. Options and warrants granted during 1998 are as follows:

                Range of           Share      Weighted Average   Remaining Life
             EXERCISE PRICE     OUTSTANDING    EXERCISE PRICE       (MONTHS)
Options:
             $4.75 - $5.225       47,000           $4.91                50
Warrants:
              $6.00 - $9.00       45,000            5.93                55
                  $6.75           50,000            6.75                56
                                  ------            ----                --
                                 142,000           $5.88                54

Separately from the Stock Incentive Plan, a maximum of 76,729 options at an
exercise price of $2.50 per share have been granted to certain officers of the
Company in consideration for their deferral of certain cash compensation. In
addition, the Company granted the underwriter of its initial public offering
warrants to purchase 150,000 shares of common stock at an exercise price of
$6.75 per share exercisable for four years, commencing January 14, 1999.


                                      F-10
<PAGE>

NOTE 9:  STOCK INCENTIVE PLAN - CONTINUED

The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
options. Accordingly, no compensation expense has been recognized for its
stock-based compensation plan. Had compensation cost for the Company's stock
options been determined based upon the fair value at the grant date consistent
with the methodology prescribed under FAS 123, the company's net loss in 1998
would have been increased by $94,000, or $.03 per share on a diluted basis. The
fair value of the options granted during 1998 is estimated on the date of grant
using the Black-Scholes valuation model with the following assumptions:
volatility of 38%, risk-free interest rate of 5.5% and a weighted average
expected life of 5.0 years.



NOTE 10:  PROVISION FOR INCOME TAXES

The components of income tax benefit are as follows for the years ended December
31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                        12/31/98              12/31/97
Current taxes refundable:
<S>                                                        <C>                  <C>      
      Federal                                       $           -          $    (269,900)
      State                                                     -                     -
                                                     --------------         -------------
                                                                -               (269,000)
-----                                                --------------         --------------
Deferred tax expense (benefit):
      Deferred compensation                                126,500              (199,400)
      Start up costs                                        13,700               (46,800)
      Generation of state loss carryforwards              (144,500)              (92,800)
      Generation of federal loss carryforward             (295,000)                   -
      All other changes                                     (5,200)               (6,600)
      Increase in valuation allowance                      304,500               345,600
                                                     --------------         ------------
                                                                -                    -
                                                     --------------         -------------

Income tax benefit                                   $           -         $    (269,900)
                                                     ==============         ==============
</TABLE>

As further described at Note 2, the income tax benefit is included in the
amounts due (to) from THE.

The actual income tax benefit attributable to loss from continuing operations
for the years ended December 31, 1998 and 1997 differed from the amounts
computed by applying the U.S. federal tax rate of 34 percent to loss before
income tax benefit as a result of the following:

<TABLE>
<CAPTION>
                                                                     12/31/98                    12/31/97
<S>                                                               <C>                        <C>           
Computed "expected" tax benefit                                   $     (6,100)              $    (353,100)
Timing differences related to deferred compensation                   (111,300)                     92,600
Timing differences related to depreciation and amortization           (149,300)                    (11,300)
 All other changes                                                     (28,300)                      1,900
 Increase in net operating loss carryforward                           295,000                        -
                                                                 -------------                  -------------

Income tax benefit                                                $       -                  $    (269,900)
                                                                  ==============               ==============
</TABLE>
                                      F-11
<PAGE>
                        Diversified Senior Services, Inc.
             Notes to Consolidated Financial Statements - Continued



NOTE 10:  PROVISION FOR INCOME TAXES - CONTINUED

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial reporting
purposes and the amounts reported for income tax purposes. Significant
components of the Company's deferred income tax assets are as follows. There are
no significant deferred income tax liabilities.

                                                 12/31/98           12/31/97
Non-current deferred tax asset:
      Deferred compensation                   $       72,900      $    199,400
      Start-up costs                                  33,100            46,800
      State operating loss carryforwards             237,300            92,800
      Federal operating loss carryforward            295,000               -
      All others                                      11,800             6,600
                                                     650,100           345,600
      Valuation allowance                           (650,100)         (345,600)
                                              --------------      --------------

Net deferred tax asset                        $           -       $          -
                                              ==============      =============

From May 17, 1996 (Date of Inception) through January 13, 1998, the Company was
included in the consolidated federal return of THE; therefore, loss
carryforwards for federal purposes have been utilized. Effective January 14,
1998, DSS and its subsidiaries will file a consolidated federal return separate
from THE.

At December 31, 1998 the Company and its subsidiaries had operating loss
carryforwards available to reduce future state and federal taxable income. These
carryforwards are subject to examination by taxing authorities and if not
previously utilized, expire as follows:

                                                     FEDERAL           STATE

                                    2001       $          -     $  (1,228,600)
                                    2002                  -          (495,000)
                                    2003                  -          (732,300)
                                    2018            (867,500)        (135,200)



NOTE 11:  COMMITMENTS AND CONTINGENCIES

The Company has various operating leases for office space and equipment. Future
minimum lease payments of $133,277 are as follows for the years ending December
31:

                                    1999                      $      44,488
                                    2000                      $      45,362
                                    2001                      $      27,404
                                    2002                      $      15,345
                                    2003                      $         678

Rent expense for the years ended December 31, 1998 and 1997 was $103,228 and
$74,217, respectively. Beginning in May 1997, the Company entered into a
month-to-month sublease with THE for office space for its corporate headquarters
with required monthly rent payments of $2,700. During 1999, the monthly rent
will increase to $3,800. Beginning in April, 1998, the Company entered into a
month-to-month lease with a non-related third party for office space in New
York, New York, occupied by its subsidiary, DSS Funding, Inc. Rent payments for
the New York office are approximately $2,200 per month. In addition, RPM leases
computer equipment from THE, with monthly payments of $501.

The Company is obligated to pay $40,000 in 1999 to a non-related third party for
consulting services and $3,500 per month to a public relations firm through
January 31, 2000.

                                      F-12
<PAGE>
                        Diversified Senior Services, Inc.
             Notes to Consolidated Financial Statements - Continued



NOTE 12:  SUBSEQUENT EVENTS

During the third quarter of 1998, the Company entered into a letter of intent to
purchase lease rights for five assisted living facilities from a third party.
During the fourth quarter of 1998, the parties mutually agreed not to proceed
with the arrangement as structured. While the Company and the owner continue to
explore alternative structures, the owner is also in discussion with other
potential buyers. No new arrangement has been agreed upon.


                                      F-13