UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549



Form 10-Q



(Mark One)

[X]

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



For the quarterly period ended June 30, 2008





[ ]

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 0-15676





DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

(Exact name of registrant as specified in its charter)



|                                |                     
|------------------------------- | --------------------
|Delaware                        | 62-1242599          
|(State or other jurisdiction of | (I.R.S. Employer    
|incorporation or organization)  | (Identification No.)



|                                                    
|----------------------------------------------------
|55 Beattie Place, P.O. Box 1089                     
|Greenville, South Carolina  29602                   
|(Address of principal executive offices)            
|                                                    
|(864) 239-1000                                      
|(Registrant's telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

[X] Yes  [ ] No



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.



|                                                                        |                              
|----------------------------------------------------------------------- | -----------------------------
|Large accelerated filer [ ]                                             | Accelerated filer [ ]        
|Non-accelerated filer [ ]
(Do not check if a smaller reporting company) | Smaller reporting company [X]



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes  [X] No











PART I - FINANCIAL INFORMATION



ITEM 1.

FINANCIAL STATEMENTS





DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED BALANCE SHEETS

(in thousands, except unit data)



|                                            |             |             
|------------------------------------------- | ----------- | ------------
|                                            | June 30,    | December 31,
|                                            | 2008        | 2007        
|                                            | (Unaudited) | (Note)      
|Assets                                      |             |             
|Cash and cash equivalents                   | $    138    | $    210    
|Receivables and deposits                    | 675         | 363         
|Other assets                                | 146         | 179         
|Restricted escrow                           | 273         | 410         
|Investment property:                        |             |             
|Land                                        | 2,047       | 2,047       
|Buildings and related personal property     | 28,190      | 27,695      
|                                            | 30,237      | 29,742      
|Less accumulated depreciation               | (19,208)    | (18,631)    
|                                            | 11,029      | 11,111      
|                                            | $12,261     | $12,273     
|                                            |             |             
|Liabilities and Partners' Deficit           |             |             
|Liabilities                                 |             |             
|Accounts payable                            | $    92     | $   454     
|Tenant security deposit liabilities         | 84          | 79          
|Accrued property taxes                      | 72          | --          
|Other liabilities                           | 448         | 246         
|Deferred tax liability (Note D)             | 77          | 77          
|Due to affiliates (Note C)                  | 6,694       | 6,126       
|Mortgage note payable                       | 15,336      | 15,336      
|                                            | 22,803      | 22,318      
|                                            |             |             
|Partners' Deficit                           |             |             
|General partners                            | (212)       | (202)       
|Limited partners (1,010.50 units issued and | (10,330)    | (9,843)     
|outstanding)                                | (10,542)    | (10,045)    
|                                            | $12,261     | $12,273     



Note:

The consolidated balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements.



See Accompanying Notes to Consolidated Financial Statements













DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per unit data)







|                                 |                    |                  |           |          
|-------------------------------- | ------------------ | ---------------- | --------- | ---------
|                                 | Three Months Ended | Six Months Ended
|                                 | June 30,           | June 30,        
|                                 | 2008               | 2007             | 2008      | 2007     
|Revenues:                        |                    |                  |           |          
|Rental income                    | $    768           | $    876         | $  1,607  | $  1,744 
|Other income                     | 213                | 200              | 395       | 354      
|Total revenues                   | 981                | 1,076            | 2,002     | 2,098    
|                                 |                    |                  |           |          
|Expenses:                        |                    |                  |           |          
|Operating                        | 364                | 489              | 950       | 1,002    
|General and administrative       | 39                 | 43               | 77        | 85       
|Depreciation                     | 283                | 284              | 557       | 568      
|Interest                         | 467                | 484              | 949       | 972      
|Property taxes                   | 36                 | 31               | 72        | 64       
|Total expenses                   | 1,189              | 1,331            | 2,605     | 2,691    
|                                 |                    |                  |           |          
|Casualty gain (Note F)           | 106                | --               | 106       | --       
|                                 |                    |                  |           |          
|Net loss                         | $(102)             | $(255)           | $(497)    | $(593)   
|Net loss allocated to general    |                    |                  |           |          
|partners (2%)                    | $     (2)          | $     (5)        | $    (10) | $    (12)
|Net loss allocated to limited    |                    |                  |           |          
|partners (98%)                   | (100)              | (250)            | (487)     | (581)    
|                                 | $(102)             | $(255)           | $(497)    | $(593)   
|Net loss per limited partnership |                    |                  |           |          
|unit                             | $(98.96)           | $(247.34)        | $(481.94) | $(574.82)



See Accompanying Notes to Consolidated Financial Statements















DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT

(Unaudited)

(in thousands, except unit data)







|                               |             |          |           |          
|------------------------------ | ----------- | -------- | --------- | ---------
|                               | Limited     |          |           |          
|                               | Partnership | General  | Limited   |          
|                               | Units       | Partners | Partners  | Total    
|                               |             |          |           |          
|Original capital contributions | 1,013.0     | $1       | $20,240   | $20,241  
|                               |             |          |           |          
|Partners' deficit at           |             |          |           |          
|December 31, 2007              | 1,010.50    | $  (202) | $ (9,843) | $(10,045)
|                               |             |          |           |          
|Net loss for the six months    |             |          |           |          
|ended June 30, 2008            | --          | (10)     | (487)     | (497)    
|                               |             |          |           |          
|Partners' deficit at           |             |          |           |          
|June 30, 2008                  | 1,010.50    | $(212)   | $(10,330) | $(10,542)



See Accompanying Notes to Consolidated Financial Statements











DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)







|                                                            |                  |         
|----------------------------------------------------------- | ---------------- | --------
|                                                            | Six Months Ended
|                                                            | June 30,        
|                                                            | 2008             | 2007    
|Cash flows from operating activities:                       |                  |         
|Net loss                                                    | $  (497)         | $  (593)
|Adjustments to reconcile net loss to net cash provided by   |                  |         
|operating activities:                                       |                  |         
|Depreciation                                                | 557              | 568     
|Amortization of loan costs                                  | 7                | 7       
|Bad debt expense                                            | 79               | 13      
|Casualty gain                                               | (106)            | --      
|Change in accounts:                                         |                  |         
|Receivables and deposits                                    | (289)            | (131)   
|Other assets                                                | 26               | (62)    
|Accounts payable                                            | (101)            | (1)     
|Tenant security deposit liabilities                         | 5                | 2       
|Accrued property taxes                                      | 72               | 65      
|Other liabilities                                           | 202              | 1       
|Due to affiliates                                           | 125              | 249     
|Net cash provided by operating activities                   | 80               | 118     
|                                                            |                  |         
|Cash flows from investing activities:                       |                  |         
|Net withdrawal from restricted escrow                       | 387              | --      
|Net deposit to restricted escrow                            | (250)            | --      
|Property improvements and replacements                      | (732)            | (185)   
|Net cash used in investing activities                       | (595)            | (185)   
|                                                            |                  |         
|Cash flows provided by financing activities:                |                  |         
|Advances received from affiliate                            | 443              | --      
|                                                            |                  |         
|Net decrease in cash and cash equivalents                   | (72)             | (67)    
|Cash and cash equivalents at beginning of period            | 210              | 282     
|Cash and cash equivalents at end of period                  | $138             | $215    
|                                                            |                  |         
|Supplemental disclosure of cash flow information:           |                  |         
|Cash paid for interest, net of capitalized interest         | $816             | $709    
|                                                            |                  |         
|Supplemental disclosure of non-cash activity:               |                  |         
|Property improvements and replacements included in accounts |                  |         
|payable                                                     | $7               | $44     
|                                                            |                  |         
|Insurance proceeds held on deposit with mortgage lender     | $102             | $--     



Included in property improvements and replacements for the six months ended June 30, 2008 are approximately $268,000 of property improvements and replacements, which were included in accounts payable at December 31, 2007.



See Accompanying Notes to Consolidated Financial Statements











DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Note A  Going Concern



The accompanying unaudited consolidated financial statements have been prepared assuming Davidson Diversified Real Estate III, L.P., (the Partnership or Registrant), will continue as a going concern.  The Partnership has recurring operating losses, an accumulated deficit, and as of June 30, 2008 and December 31, 2007 had approximately $6,683,000 and $6,114,000, respectively, of advances and related accrued interest due to an affiliate of Davidson Diversified Properties, Inc. (the "Managing General Partner").  In a letter dated April 4, 2006, this affiliate of the Managing General Partner demanded payment in full of all outstanding advances owed by the Partnership to it, plus related accrued interest.  The Partnership does not have sufficient assets to repay the advances and related accrued interest.  In addition, the Partnership does not believe that the proceeds from a refinancing of the mortgage of the Partnerships sole investment property would be sufficient to repay the existing first mortgage plus the advances and related accrued interest due to an affiliate of the managing general partner. The Partnership has defaulted on its repayment of the advances due to an affiliate of the managing general partner; and therefore, the affiliate of the managing general partner may take legal action, which would include foreclosure of the Partnerships sole investment property. The managing general partner is continuing to evaluate its options relative to the payment demand by an affiliate of the managing general partner.



As a result of the above, there is substantial doubt about the Partnerships ability to continue as a going concern.  The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.



Note B - Basis of Presentation



The accompanying unaudited consolidated financial statements of the Partnership have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the Managing General Partner, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. For further information, refer to the consolidated financial statements and footnotes thereto included in the Partnership's Annual Report on Form 10-KSB for the year ended December 31, 2007. The Managing General Partner is a wholly owned subsidiary of Apartment Investment and Management Company ("AIMCO"), a publicly traded real estate investment trust.



Certain reclassifications have been made to the 2007 balances to conform to the 2008 presentation.



Note C - Transactions with Affiliated Parties



The Partnership has no employees and depends on the Managing General Partner and its affiliates for the management and administration of all Partnership activities. The Partnership Agreement provides for certain payments to affiliates for services and reimbursement of certain expenses incurred by affiliates on behalf of the Partnership. The following payments were paid or accrued to the Managing General Partner and affiliates during the six months ended June 30, 2008 and 2007.



Affiliates of the Managing General Partner receive 5% of gross receipts from the Partnership's investment property as compensation for providing property management services. The Partnership paid to such affiliates approximately $98,000 and $102,000 for the six months ended June 30, 2008 and 2007, respectively, which is included in operating expenses.



Affiliates of the Managing General Partner charged the Partnership reimbursement of accountable administrative expenses amounting to approximately $124,000 and $60,000 for the six months ended June 30, 2008 and 2007, respectively, which is included in general and administrative expenses and investment property. The portion of these reimbursements included in investment property for the six months ended June 30, 2008 and 2007 are construction management services provided by an affiliate of the Managing General Partner of approximately $84,000 and $6,000, respectively. At June 30, 2008 and December 31, 2007, approximately $11,000 and $12,000, respectively, of reimbursements for services were accrued by the Partnership and are included in due to affiliates on the accompanying consolidated balance sheets.



In accordance with the Partnership Agreement, AIMCO Properties, L.P., an affiliate of the Managing General Partner, advanced the Partnership approximately $443,000 during the six months ended June 30, 2008 to fund operating expenses at Plainview Apartments.  There were no advances made to the Partnership during the six months ended June 30, 2007.  At June 30, 2008 and December 31, 2007, the balances of the advances, including accrued interest, owed to AIMCO Properties, L.P., was approximately $6,683,000 and $6,114,000, respectively, and is included in due to affiliates on the accompanying consolidated balance sheets.  Interest is charged at the prime rate plus 1% (6.00% at June 30, 2008).  Interest expense was approximately $226,000 and $257,000 for the six months ended June 30, 2008 and 2007, respectively.  The Partnership repaid approximately $100,000 of accrued interest during the six months ended June 30, 2008.  There were no payments made during the six months ended June 30, 2007.  During 2006, AIMCO Properties, L.P. demanded payment in full of all the outstanding advances and related accrued interest.  See Note A  Going Concern for further discussion.  The Partnership may receive additional advances of funds from AIMCO Properties, L.P. although AIMCO Properties, L.P. is not obligated to provide such advances.  For more information on AIMCO Properties, L.P., including copies of its audited balance sheet, please see its reports filed with the Securities and Exchange Comission.



The Partnership insures its property up to certain limits through coverage provided by AIMCO which is generally self-insured for a portion of losses and liabilities related to workers compensation, property casualty, general liability and vehicle liability.  The Partnership insures its property above the AIMCO limits through insurance policies obtained by AIMCO from insurers unaffiliated with the Managing General Partner.  During the six months ended June 30, 2008, the Partnership was charged by AIMCO and its affiliates approximately $49,000 for hazard insurance coverage and fees associated with policy claims administration.  Additional charges will be incurred by the Partnership during 2008 as other insurance policies renew later in the year. The Partnership was charged by AIMCO and its affiliates approximately $112,000 for insurance coverage and fees associated with policy claims administration during the year ended December 31, 2007.



Note D  Partnership Income Taxes



The state of Kentucky enacted tax legislation, effective for years beginning on or after January 1, 2005, concerning income taxes that impact the Partnership.  The Partnership was liable for any Kentucky income taxes that arose as a result of the Partnerships property, Plainview Apartments, being located in the state of Kentucky.  During the year ended December 31, 2005, the Partnership estimated and recorded a deferred tax liability of approximately $276,000 as a result of this tax legislation. During the year ended December 31, 2006, the Partnership reduced the estimated deferred tax liability by approximately $56,000. During 2007, the state of Kentucky revised its tax legislation such that the Partnership will no longer be subject to Kentucky state income tax.  The Partnership is now subject to a Limited Liability Entity tax that is based upon the Partnerships gross receipts in Kentucky.  As a result of this change in tax legislation, the Partnership reduced the associated estimated deferred tax liability by approximately $220,000 during the fourth quarter of 2007.  As of December 31, 2007, the Partnership no longer has a deferred tax liability with respect to Kentucky state income tax. The Partnerships property, Plainview Apartments, is subject to local taxes based upon net profits. During the fourth quarter of 2007, the Partnership recorded a deferred tax liability of approximately $77,000 related to this local tax.  The Partnerships deferred tax liability at June 30, 2008 and December 31, 2007 is approximately $77,000 and consists primarily of temporary differences related to land, buildings and accumulated depreciation.



Note E - Contingencies



In March 1998, several putative unit holders of limited partnership units of the Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, its Managing General Partner and several of their affiliated partnerships and corporate entities. The action purported to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) that are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities that were, at one time, affiliates of Insignia; past tender offers by the Insignia affiliates to acquire limited partnership units; management of the partnerships by the Insignia affiliates; and the series of transactions which closed on October 1, 1998 and February 26, 1999 whereby Insignia and Insignia Properties Trust, respectively, were merged into AIMCO. The plaintiffs sought monetary damages and equitable relief, including judicial dissolution of the Partnership. In addition, during the third quarter of 2001, a complaint captioned Heller v. Insignia Financial Group (the "Heller action") was filed against the same defendants that are named in the Nuanes action. On or about August 6, 2001, plaintiffs filed a first amended complaint. The Heller action was brought as a purported derivative action, and asserted claims for, among other things, breach of fiduciary duty, unfair competition, conversion, unjust enrichment, and judicial dissolution. On January 28, 2002, the trial court granted defendants motion to strike the complaint.  Plaintiffs took an appeal from this order.



On January 8, 2003, the parties filed a Stipulation of Settlement in proposed settlement of the Nuanes action and the Heller action. On June 13, 2003, the court granted final approval of the settlement and entered judgment in both the Nuanes and Heller actions. On August 12, 2003, an objector ("Objector") filed an appeal (the Appeal) seeking to vacate and/or reverse the order approving the settlement and entering judgment thereto. On May 4, 2004, the Objector filed a second appeal challenging the courts use of a referee and its order requiring Objector to pay those fees.



On March 21, 2005, the Court of Appeals issued opinions in both pending appeals.  With regard to the settlement and judgment entered thereto, the Court of Appeals vacated the trial courts order and remanded to the trial court for further findings on the basis that the state of the record is insufficient to permit meaningful appellate review.  The matter was transferred back to the trial court on June 21, 2005.  With regard to the second appeal, the Court of Appeals reversed the order requiring the Objector to pay referee fees. With respect to the related Heller appeal, on July 28, 2005, the Court of Appeals reversed the trial courts order striking the first amended complaint.



On August 18, 2005, Objector and his counsel filed a motion to disqualify the trial court based on a peremptory challenge and filed a motion to disqualify for cause on October 17, 2005, both of which were ultimately denied and/or struck by the trial court.  On or about October 13, 2005 Objector filed a motion to intervene and on or about October 19, 2005 filed both a motion to take discovery relating to the adequacy of plaintiffs as derivative representatives and a motion to dissolve the anti-suit injunction in connection with settlement.  On November 14, 2005, Plaintiffs filed a Motion For Further Findings pursuant to the remand ordered by the Court of Appeals. Defendants joined in that motion.  On February 3, 2006, the Court held a hearing on the various matters pending before it and ordered additional briefing from the parties and Objector. On June 30, 2006, the trial court entered an order confirming its approval of the class action settlement and entering judgment thereto after the Court of Appeals had remanded the matter for further findings.  The substantive terms of the settlement agreement remain unchanged.  The trial court also entered supplemental orders on July 1, 2006, denying Objectors Motion to File a Complaint in Intervention, Objectors Motion for Leave of Discovery and Objectors Motion to Dissolve the Anti-Suit Injunction.  Notice of Entry of Judgment was served on July 10, 2006.



On August 31, 2006, the Objector filed a Notice of Appeal to the Courts June 30, 2006 and July 1, 2006 orders. The matter was argued and submitted and the Court of Appeal issued an opinion on February 20, 2008 affirming the order approving the settlement and judgment entered thereto. On March 12, 2008, the Court of Appeal denied Appellants Petition for Re-Hearing. On May 21, 2008, the California Supreme Court denied Appellants Petition for Review.  Objector has until August 19,2008 to file a petition for certiorari with the United States Supreme Court.



The Managing General Partner does not anticipate that any costs to the Partnership, whether legal or settlement costs, associated with these cases will be material to the Partnerships overall operations.



As previously disclosed, AIMCO Properties, L.P. and NHP Management Company, both affiliates of the Managing General Partner, were defendants in a lawsuit, filed as a collective action in August 2003 in the United States District Court for the District of Columbia, alleging that they willfully violated the Fair Labor Standards Act (FLSA) by failing to pay maintenance workers overtime for time worked in excess of 40 hours per week (overtime claims).  The plaintiffs also contended that AIMCO Properties, L.P. and NHP Management Company failed to compensate maintenance workers for time that they were required to be "on-call" (on-call claims).  In March 2007, the court in the District of Columbia decertified the collective action.  In July 2007, plaintiffs counsel filed individual cases in Federal court in 22 jurisdictions.  In the second quarter 2008, AIMCO Properties, L.P. settled the overtime cases involving 652 plaintiffs and established a framework for resolving the 88 remaining on-call claims and the attorneys fees claimed by plaintiffs counsel.  As a result, the lawsuits asserted in the 22 Federal courts will be dismissed.  At this time, affiliates of the Managing General Partner are attempting to obtain additional information to determine the most equitable allocation of settlement amounts and attorneys fees.  The Managing General Partner is uncertain as to the amount of loss, if any, allocable to the Partnership.  Therefore, the Partnership cannot estimate whether a loss will occur or a potential range of loss.



The Partnership is unaware of any other pending or outstanding litigation matters involving it or its investment property that are not of a routine nature arising in the ordinary course of business.



Environmental



Various Federal, state and local laws subject property owners or operators to liability for management, and the costs of removal or remediation, of certain hazardous substances present on a property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of the hazardous substances. The presence of, or the failure to manage or remedy properly, hazardous substances may adversely affect occupancy at affected apartment communities and the ability to sell or finance affected properties. In addition to the costs associated with investigation and remediation actions brought by government agencies, and potential fines or penalties imposed by such agencies in connection therewith, the presence of hazardous substances on a property could result in claims by private plaintiffs for personal injury, disease, disability or other infirmities. Various laws also impose liability for the cost of removal, remediation or disposal of hazardous substances through a licensed disposal or treatment facility. Anyone who arranges for the disposal or treatment of hazardous substances is potentially liable under such laws. These laws often impose liability whether or not the person arranging for the disposal ever owned or operated the disposal facility. In connection with the ownership, operation and management of its property, the Partnership could potentially be liable for environmental liabilities or costs associated with its property.



Mold



The Partnership is aware of lawsuits against owners and managers of multifamily properties asserting claims of personal injury and property damage caused by the presence of mold, some of which have resulted in substantial monetary judgments or settlements.  The Partnership has only limited insurance coverage for property damage loss claims arising from the presence of mold and for personal injury claims related to mold exposure.  Affiliates of the Managing General Partner have implemented policies, procedures, third-party audits and training and the Managing General Partner believes that these measures will prevent or eliminate mold exposure and will minimize the effects that mold may have on residents. During 2003, the Partnership completed a rehabilitation project at Plainview Apartments which cost approximately $5,300,000. Part of the rehabilitation project was to address mold abatement conditions with the rest relating to general updating of the property.  Because the law regarding mold is unsettled and subject to change the Managing General Partner can make no assurance that liabilities resulting from the presence of or exposure to mold will not have a material adverse effect on the Partnerships consolidated financial condition or results of operations.



Note F  Casualty Events



In May 2007, Plainview Apartments suffered significant fire damage to one of the propertys buildings.  During 2007, the Partnership estimated that the cost to repair the building was approximately $824,000. During the three and six months ended June 30, 2008, it was determined that the actual cost to repair the building was approximately $683,000. During the year ended December 31, 2007, the Partnership received insurance proceeds of approximately $581,000 for building replacements. During the year ended December 31, 2007, the Partnership recognized a casualty gain of approximately $518,000 as a result of receiving approximately $581,000 of insurance proceeds offset by approximately $63,000 of undepreciated assets being written off. During the six months ended June 30, 2008, the Partnership received additional insurance proceeds related to this casualty of approximately $218,000, of which approximately $102,000 was for building replacements and approximately $116,000 covered emergency repairs expensed in 2007. The Partnership recognized an additional casualty gain of approximately $106,000 during the six months ended June 30, 2008 as a result of the receipt of insurance proceeds of approximately $102,000 and a change in the previous write off of undepreciated damaged assets of approximately $4,000. During the three months ended June 30, 2008, the Partnership also received approximately $15,000 for lost rents as a result of the casualty.



In May 2008, Plainview Apartments suffered fire damages to five rental units as a result of an electrical fire. The preliminary estimated cost to repair the units is approximately $821,000. It is currently estimated that insurance proceeds will cover the costs to replace the damaged assets and no casualty loss will be recognized. During the six months ended June 30, 2008, the Partnership received initial insurance proceeds of approximately $250,000 which are currently held in an escrow account with the mortgage lender. The Partnership anticipates receiving additional insurance proceeds in 2008.



Note G  Abandonment of Units



During the year ended December 31, 2007, the number of limited partnership units (the Units) decreased by 0.25 Units due to limited partners abandoning their Units. In abandoning his or her Units, a limited partner relinquishes all right, title and interest in the Partnership as of the date of abandonment. The loss per Unit on the accompanying consolidated statements of operations is calculated based on the number of Units outstanding at June 30, 2008 and 2007, which was 1,010.50 and 1,010.75, respectively.











ITEM 2.

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



The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements in certain circumstances. Certain information included in this Report contains or may contain information that is forward-looking, including, without limitation, statements regarding the effect of redevelopments, the Partnerships future financial performance, including the Partnerships ability to maintain current or meet projected occupancy and rent levels, and the effect of government regulations. Actual results may differ materially from those described in the forward-looking statements and, in addition, will be affected by a variety of risks and factors that are beyond the Partnerships control including, without limitation: natural disasters such as hurricanes; national and local economic conditions; the general level of interest rates; energy costs; the terms of governmental regulations that affect the Partnerships property and interpretations of those regulations; the competitive environment in which the Partnership operates; financing risks, including the risk that the Partnerships cash flows from operations may be insufficient to meet required payments of principal and interest; real estate risks, including fluctuations in real estate values and the general economic climate in local markets and competition for tenants in such markets; insurance risks; development risks; litigation, including costs associated with prosecuting or defending claims and any adverse outcomes; and possible environmental liabilities, including costs, fines or penalties that may be incurred due to necessary remediation of contamination of properties presently owned or previously owned by the Partnership. Readers should carefully review the Partnerships consolidated financial statements and the notes thereto and the other documents the Partnership files from time to time with the Securities and Exchange Commission.



The Partnerships investment property consists of one apartment complex, Plainview Apartments, located in Louisville, Kentucky.  The average occupancy of the property for the six months ended June 30, 2008 and 2007 was 93% and 95%, respectively.



The Partnerships financial results depend upon a number of factors including the ability to attract and maintain tenants at the investment property, interest rates on mortgage loans, costs incurred to operate the investment property, general economic conditions and weather. As part of the ongoing business plan of the Partnership, the Managing General Partner monitors the rental market environment of its investment property to assess the feasibility of increasing rents, maintaining or increasing occupancy levels and protecting the Partnership from increases in expenses. As part of this plan, the Managing General Partner attempts to protect the Partnership from the burden of inflation-related increases in expenses by increasing rents and maintaining a high overall occupancy level. However, the Managing General Partner may use rental concessions and rental rate reductions to offset softening market conditions, accordingly, there is no guarantee that the Managing General Partner will be able to sustain such a plan. Further, a number of factors that are outside the control of the Partnership such as the local economic climate and weather can adversely or positively affect the Partnerships financial results.



Results of Operations



The Partnership recognized net losses of approximately $102,000 and $497,000 for the three and six months ended June 30, 2008, compared to net losses of approximately $255,000 and $593,000 for the three and six months ended June 30, 2007. The decrease in net loss for both the three and six months ended June 30, 2008 is due to a decrease in total expenses and the recognition of a casualty gain during 2008, partially offset by a decrease in total revenues.



Total expenses decreased for both the three and six months ended June 30, 2008 due to decreases in operating, general and administrative and interest expenses, partially offset by an increase in property tax expense. The decrease in total expenses for the six months ended June 30, 2008 was also due to a decrease in depreciation expense. Depreciation expense remained relatively constant for the three months ended June 30, 2008. Operating expense decreased for both the three and six months ended June 30, 2008 due to decreases in hazard insurance premiums and insurance proceeds received to cover emergency expenses related to the May 2007 fire casualty discussed below, partially offset by an increase in utilities at Plainview Apartments. Operating expense also decreased for the three month period due to a decrease in contract services at the Partnerships investment property. Interest expense decreased for both periods due to a decrease in the interest charged on advances from affiliates, as result of a decrease in the variable interest rate charged. Property tax expense increased for both periods due to an increase in the assessed value at Plainview Apartments. Depreciation expense decreased for the six months ended June 30, 2008 due to assets written off in 2007 related to the May 2007 fire casualty, partially offset by fixed assets placed into service during the past twelve months.



General and administrative expenses decreased for both the three and six months ended June 30, 2008 due to a decrease in reimbursements to the Managing General Partner as allowed under the Partnership Agreement associated with management of the Partnership. Also included in general and administrative expenses for the three and six months ended June 30, 2008 and 2007 are costs associated with the quarterly and annual communications with investors and regulatory agencies and the annual audit required by the Partnership Agreement.



In May 2007, Plainview Apartments suffered significant fire damage to one of the propertys buildings.  During 2007, the Partnership estimated that the cost to repair the building was approximately $824,000. During the three and six months ended June 30, 2008, it was determined that the actual cost to repair the building was approximately $683,000. During the year ended December 31, 2007, the Partnership received insurance proceeds of approximately $581,000 for building replacements. During the year ended December 31, 2007, the Partnership recognized a casualty gain of approximately $518,000 as a result of receiving approximately $581,000 of insurance proceeds offset by approximately $63,000 of undepreciated assets being written off. During the six months ended June 30, 2008, the Partnership received additional insurance proceeds related to this casualty of approximately $218,000, of which approximately $102,000 was for building replacements and approximately $116,000 covered emergency repairs expensed in 2007. The Partnership recognized an additional casualty gain of approximately $106,000 during the six months ended June 30, 2008 as a result of the receipt of insurance proceeds of approximately $102,000 and a change in the previous write off of undepreciated damaged assets of approximately $4,000. During the three months ended June 30, 2008, the Partnership also received approximately $15,000 for lost rents as a result of the casualty.



Total revenues decreased for both the three and six months ended June 30, 2008 due to a decrease in rental income, partially offset by an increase in other income. The decrease in rental income for both periods is primarily due to decreases in both occupancy and the average rental rate and increased bad debt expense at Plainview Apartments. Other income increased for both periods due to increases in late charges and lease cancellation fees, partially offset by decreases in resident utility reimbursements and interest income at the Partnership, due to a lower average cash balance.



Liquidity and Capital Resources



At June 30, 2008, the Partnership had cash and cash equivalents of approximately $138,000, compared to approximately $215,000 at June 30, 2007. The decrease in cash and cash equivalents of approximately $72,000, from December 31, 2007, is due to approximately $595,000 of cash used in investing activities, partially offset by approximately $443,000 and $80,000 of cash provided by financing and operating activities, respectively. Cash used in investing activities consisted of property improvements and replacements and net deposits to a restricted escrow, partially offset by net withdrawals from a restricted escrow maintained by the mortgage lender.  Cash provided by financing activities consisted of advances received from an affiliate of the Managing General Partner. The Partnership invests its working capital in interest bearing accounts.



The sufficiency of existing liquid assets to meet future liquidity and capital expenditure requirements is directly related to the level of capital expenditures required at the property to adequately maintain the physical assets and other operating needs of the Partnership and to comply with Federal, state, and local legal and regulatory requirements. The Managing General Partner monitors developments in the area of legal and regulatory compliance.  Capital improvements planned for the Partnership's property are detailed below.



During the six months ended June 30, 2008, the Partnership completed approximately $471,000 in capital expenditures at Plainview Apartments consisting primarily of improvements related to casualties, water heater upgrades, structural improvements, and appliance, air conditioning and floor covering replacements. These expenditures were funded from operating cash flow, insurance proceeds and advances from an affiliate of the Managing General Partner.  The Partnership regularly evaluates the capital improvement needs of the property. While the Partnership has no material commitments for property improvements and replacements, certain routine capital expenditures are anticipated during the remainder of 2008. Such capital expenditures will depend on the physical condition of the property as well as anticipated cash flow generated by the property.



Capital expenditures will be incurred only if cash is available from operations, Partnership reserves or advances from AIMCO Properties, L.P., although AIMCO Properties, L.P. does not have a commitment to fund advances to the Partnership.  To the extent that capital improvements are completed, the Partnership's distributable cash flow, if any, may be adversely affected at least in the short term.



The Partnerships assets are thought to be sufficient for any near-term needs (exclusive of capital improvements and repayment of advances owed to affiliates) of the Partnership. The Partnership does not have sufficient assets to repay the advances and related accrued interest.  In addition, the Partnership does not believe that the proceeds from a refinancing of the mortgage of the Partnerships sole investment property would be sufficient to repay the existing first mortgage plus the advances and related accrued interest due to an affiliate of the Managing General Partner. The mortgage indebtedness encumbering Plainview Apartments of approximately $15,336,000 requires monthly payments of interest only with a balloon payment of approximately $15,336,000 due November 15, 2010. The Managing General Partner will attempt to refinance such indebtedness and/or sell the property prior to maturity. If the property cannot be refinanced or sold for a sufficient amount, the Partnership will risk losing the property through foreclosure.



There were no distributions to the partners during the six months ended June 30, 2008 and 2007. Future cash distributions will depend on the levels of net cash generated from operations, the timing of debt maturity, property sale and/or refinancing. The Partnership's cash available for distribution is reviewed on a monthly basis. In light of the amounts accrued and payable to an affiliate of the Managing General Partner at June 30, 2008, and the related demand notice received from an affiliate of the Managing General Partner, the Partnership does not anticipate making any distributions to its partners in the foreseeable future.



In May 2008, Plainview Apartments suffered fire damages to five rental units as a result of an electrical fire. The preliminary estimated cost to repair the units is approximately $821,000. It is currently estimated that insurance proceeds will cover the costs to replace the damaged assets and no casualty loss will be recognized. During the six months ended June 30, 2008, the Partnership received initial insurance proceeds of approximately $250,000 which are currently held in an escrow account with the mortgage lender. The Partnership anticipates receiving additional insurance proceeds in 2008.



Other



In addition to its indirect ownership of the managing general partner interest in the Partnership, AIMCO and its affiliates owned 440.50 limited partnership units (the Units) in the Partnership representing 43.59% of the outstanding Units at June 30, 2008. A number of these Units were acquired pursuant to tender offers made by AIMCO or its affiliates. It is possible that AIMCO or its affiliates will acquire additional Units in exchange for cash or a combination of cash and units in AIMCO Properties, L.P., the operating partnership of AIMCO, either through private purchases or tender offers. Pursuant to the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters that include, but are not limited to, voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner.  As a result of its ownership of 43.59% of the outstanding Units, AIMCO and its affiliates are in a position to influence all such voting decisions with respect to the Partnership. Although the Managing General Partner owes fiduciary duties to the limited partners of the Partnership, the Managing General Partner also owes fiduciary duties to AIMCO as its sole stockholder. As a result, the duties of the Managing General Partner, as managing general partner, to the Partnership and its limited partners may come into conflict with the duties of the Managing General Partner to AIMCO as its sole stockholder.



Critical Accounting Policies



The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Partnership to make estimates and assumptions. The Partnership believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity.



Impairment of Long-Lived Asset



Investment property is recorded at cost, less accumulated depreciation, unless the carrying amount of the asset is not recoverable.  If events or circumstances indicate that the carrying amount of the property may not be recoverable, the Partnership will make an assessment of its recoverability by comparing the carrying amount to the Partnerships estimate of the undiscounted future cash flows, excluding interest charges, of the property.   If the carrying amount exceeds the aggregate undiscounted future cash flows, the Partnership would recognize an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property.



Real property investment is subject to varying degrees of risk.  Several factors may adversely affect the economic performance and value of the Partnerships investment property.  These factors include, but are not limited to, general economic climate; competition from other apartment communities and other housing options; local conditions, such as loss of jobs or an increase in the supply of apartments that might adversely affect apartment occupancy or rental rates; changes in governmental regulations and the related cost of compliance; increases in operating costs (including real estate taxes) due to inflation and other factors, which may not be offset by increased rents; and changes in tax laws and housing laws, including the enactment of rent control laws or other laws regulating multi-family housing.  Any adverse changes in these factors could cause impairment of the Partnerships asset.



Revenue Recognition



The Partnership generally leases apartment units for twelve-month terms or less. The Partnership will offer rental concessions during particularly slow months or in response to heavy competition from other similar complexes in the area. Rental income attributable to leases, net of any concessions, is recognized on a straight-line basis over the term of the lease. The Partnership evaluates all accounts receivable from residents and establishes an allowance, after the application of security deposits, for accounts greater than 30 days past due on current tenants and all receivables due from former tenants.



ITEM 4T.

CONTROLS AND PROCEDURES



(a)

Disclosure Controls and Procedures.



The Partnerships management, with the participation of the principal executive officer and principal financial officer of the Managing General Partner, who are the equivalent of the Partnerships principal executive officer and principal financial officer, respectively, has evaluated the effectiveness of the Partnerships disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, the principal executive officer and principal financial officer of the Managing General Partner, who are the equivalent of the Partnerships principal executive officer and principal financial officer, respectively, have concluded that, as of the end of such period, the Partnerships disclosure controls and procedures are effective.



(b)

Changes in Internal Control Over Financial Reporting.



There have been no significant changes in the Partnerships internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Partnerships internal control over financial reporting.











PART II - OTHER INFORMATION





ITEM 1.

LEGAL PROCEEDINGS



In March 1998, several putative unit holders of limited partnership units of the Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, its Managing General Partner and several of their affiliated partnerships and corporate entities. The action purported to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) that are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities that were, at one time, affiliates of Insignia; past tender offers by the Insignia affiliates to acquire limited partnership units; management of the partnerships by the Insignia affiliates; and the series of transactions which closed on October 1, 1998 and February 26, 1999 whereby Insignia and Insignia Properties Trust, respectively, were merged into AIMCO. The plaintiffs sought monetary damages and equitable relief, including judicial dissolution of the Partnership. In addition, during the third quarter of 2001, a complaint captioned Heller v. Insignia Financial Group (the "Heller action") was filed against the same defendants that are named in the Nuanes action. On or about August 6, 2001, plaintiffs filed a first amended complaint. The Heller action was brought as a purported derivative action, and asserted claims for, among other things, breach of fiduciary duty, unfair competition, conversion, unjust enrichment, and judicial dissolution. On January 28, 2002, the trial court granted defendants motion to strike the complaint.  Plaintiffs took an appeal from this order.



On January 8, 2003, the parties filed a Stipulation of Settlement in proposed settlement of the Nuanes action and the Heller action. On June 13, 2003, the court granted final approval of the settlement and entered judgment in both the Nuanes and Heller actions. On August 12, 2003, an objector ("Objector") filed an appeal (the Appeal) seeking to vacate and/or reverse the order approving the settlement and entering judgment thereto. On May 4, 2004, the Objector filed a second appeal challenging the courts use of a referee and its order requiring Objector to pay those fees.



On March 21, 2005, the Court of Appeals issued opinions in both pending appeals.  With regard to the settlement and judgment entered thereto, the Court of Appeals vacated the trial courts order and remanded to the trial court for further findings on the basis that the state of the record is insufficient to permit meaningful appellate review.  The matter was transferred back to the trial court on June 21, 2005.  With regard to the second appeal, the Court of Appeals reversed the order requiring the Objector to pay referee fees. With respect to the related Heller appeal, on July 28, 2005, the Court of Appeals reversed the trial courts order striking the first amended complaint.



On August 18, 2005, Objector and his counsel filed a motion to disqualify the trial court based on a peremptory challenge and filed a motion to disqualify for cause on October 17, 2005, both of which were ultimately denied and/or struck by the trial court.  On or about October 13, 2005 Objector filed a motion to intervene and on or about October 19, 2005 filed both a motion to take discovery relating to the adequacy of plaintiffs as derivative representatives and a motion to dissolve the anti-suit injunction in connection with settlement.  On November 14, 2005, Plaintiffs filed a Motion For Further Findings pursuant to the remand ordered by the Court of Appeals. Defendants joined in that motion.  On February 3, 2006, the Court held a hearing on the various matters pending before it and ordered additional briefing from the parties and Objector. On June 30, 2006, the trial court entered an order confirming its approval of the class action settlement and entering judgment thereto after the Court of Appeals had remanded the matter for further findings.  The substantive terms of the settlement agreement remain unchanged.  The trial court also entered supplemental orders on July 1, 2006, denying Objectors Motion to File a Complaint in Intervention, Objectors Motion for Leave of Discovery and Objectors Motion to Dissolve the Anti-Suit Injunction.  Notice of Entry of Judgment was served on July 10, 2006.



On August 31, 2006, the Objector filed a Notice of Appeal to the Courts June 30, 2006 and July 1, 2006 orders. The matter was argued and submitted and the Court of Appeal issued an opinion on February 20, 2008 affirming the order approving the settlement and judgment entered thereto. On March 12, 2008, the Court of Appeal denied Appellants Petition for Re-Hearing. On May 21, 2008, the California Supreme Court denied Appellants Petition for Review.  Objector has until August 19,2008 to file a petition for certiorari with the United States Supreme Court.



The Managing General Partner does not anticipate that any costs to the Partnership, whether legal or settlement costs, associated with these cases will be material to the Partnerships overall operations.



As previously disclosed, AIMCO Properties, L.P. and NHP Management Company, both affiliates of the Managing General Partner, were defendants in a lawsuit, filed as a collective action in August 2003 in the United States District Court for the District of Columbia, alleging that they willfully violated the Fair Labor Standards Act (FLSA) by failing to pay maintenance workers overtime for time worked in excess of 40 hours per week (overtime claims).  The plaintiffs also contended that AIMCO Properties, L.P. and NHP Management Company failed to compensate maintenance workers for time that they were required to be "on-call" (on-call claims).  In March 2007, the court in the District of Columbia decertified the collective action.  In July 2007, plaintiffs counsel filed individual cases in Federal court in 22 jurisdictions.  In the second quarter 2008, AIMCO Properties, L.P. settled the overtime cases involving 652 plaintiffs and established a framework for resolving the 88 remaining on-call claims and the attorneys fees claimed by plaintiffs counsel.  As a result, the lawsuits asserted in the 22 Federal courts will be dismissed.  At this time, affiliates of the Managing General Partner are attempting to obtain additional information to determine the most equitable allocation of settlement amounts and attorneys fees.  The Managing General Partner is uncertain as to the amount of loss, if any, allocable to the Partnership.  Therefore, the Partnership cannot estimate whether a loss will occur or a potential range of loss.



ITEM 6.

EXHIBITS



See Exhibit Index.











SIGNATURES







Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





|                      |                                             
|--------------------- | --------------------------------------------
|                      | DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.  
|                      |                                             
|                      | By:   Davidson Diversified Properties, Inc.,
|                      | Managing General Partner                    
|                      |                                             
|Date: August 13, 2008 | By:   /s/Martha L. Long                     
|                      | Martha L. Long                              
|                      | Senior Vice President                       
|                      |                                             
|Date: August 13, 2008 | By:   /s/Stephen B. Waters                  
|                      | Stephen B. Waters                           
|                      | Vice President                              
|                      |                                             
|                      |                                             













DAVIDSON DIVERSIFIED REAL ESTATE III, LP

EXHIBIT INDEX





Exhibit Number

Description of Exhibit



3

Partnership Agreement dated July 8, 1985 and amended as of October 9, 1985 is incorporated by reference to Exhibit A to the Prospectus of the Registrant dated October 28, 1985 as filed with the Commission pursuant to Rule 424(b) under the Act.



3A

Second Amendment dated April 1, 1986 to the Partnership Agreement dated July 8, 1985 as amended October 9, 1985 is incorporated by reference to Exhibit 3A to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.



4

Certificate of Limited Partnership dated June 28, 1985 is incorporated by reference to Exhibit 4 to the Registrant's Registration Statement on form S-11 (Registration No. 2-99257).



10L

Contract for Sale of Real Estate for Plainview Apartments dated November 11, 1985 between NTS-Plainview Partners, a Kentucky limited partnership and Tennessee Trust Company, a Tennessee corporation, is incorporated by reference to Exhibit 10(a) to the Registrant's Current Report on Form 8-K dated May 6, 1986.



10M

Assignment of Contract for Sale of Real Estate dated May 2, 1986 between Tennessee Trust Company, a Tennessee corporation and the Registrant is incorporated by reference to Exhibit 10(b) to the Registrant's Current Report on Form 8-K dated May 6, 1986.



10N

Amendment and Reinstatement of Contract for Sale of Real Estate dated April 15, 1986 between NTS-Plainview Partners and Tennessee Trust Company is incorporated by reference to Exhibit 10(c) to the Registrant's Current Report on Form 8-K dated May 6, 1986.



10AA

Amended, Restated and Substituted Mortgage Note dated November 15, 1995, executed by Plainview Apartments, L.P. payable to NTS-Plainview Associates is incorporated by reference to Exhibit 10AA to the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1995.



10BB

Assignment of Leases, Rents, and Profits dated November 15, 1995, executed by Plainview Apartments, L.P. to Nationwide Life Insurance Co. and West Coast Life Insurance Co. is incorporated by reference to Exhibit 10BB to the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1995.



31.1

Certification of equivalent of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



31.2

Certification of equivalent of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



32.1

Certification of the equivalent of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



99A

Agreement of Limited Partnership for Davidson III GP Limited Partnership between Davidson Diversified Properties, Inc. and Davidson Diversified Real Estate III entered into on September 15, 1993.