FORM 10-QSB--QUARTERLY OR TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                        Quarterly or Transitional Report


                     U.S. Securities And Exchange Commission
                             Washington, D.C. 20549

                                   Form 10-QSB

(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, 2001


[ ] 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 small business issuer 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
                           (Issuer's telephone number)


Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes X No___



<PAGE>



                         PART I - FINANCIAL INFORMATION


ITEM 1.     FINANCIAL STATEMENTS

a)

                     DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                           CONSOLIDATED BALANCE SHEET
                                   (Unaudited)
                          (in thousands, except unit data)


                                  June 30, 2001
<TABLE>
<CAPTION>


Assets
<S>                                                                          <C>
   Cash and cash equivalents                                                 $   219
   Receivables and deposits                                                      170
   Restricted escrows                                                            136
   Other assets                                                                  333
   Investment properties:
      Land                                                    $ 2,821
      Buildings and related personal property                   33,990
                                                                          36,811
      Less accumulated depreciation                            (20,532)       16,279
                                                                            $ 17,137

Liabilities and Partners' Deficit
Liabilities
   Accounts payable                                                          $ 120
   Tenant security deposit liabilities                                            94
   Accrued property taxes                                                        325
   Other liabilities                                                             353
   Due to affiliates                                                             118
   Mortgage notes payable                                                     23,449

Partners' Deficit
   General partners                                            $ (146)
   Limited partners (1,011.5 units issued and
      outstanding)                                              (7,176)       (7,322)
                                                                            $ 17,137

            See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>


b)


                     DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                          (in thousands, except unit data)

<TABLE>
<CAPTION>

                                        Three Months Ended         Six Months Ended
                                             June 30,                  June 30,
                                         2001         2000         2001         2000

Revenues:
<S>                                    <C>          <C>          <C>           <C>
  Rental income                        $ 1,323      $ 1,451      $ 2,682       $ 2,827
  Other income                              181          137          349          269
      Total revenues                      1,504        1,588        3,031        3,096

Expenses:
  Operating                                 698          552        1,340        1,167
  General and administrative                 65           52          125           91
  Depreciation                              433          393          864          797
  Interest                                  535          539        1,072        1,075
  Property taxes                            139           61          244          158
      Total expenses                      1,870        1,597        3,645        3,288

Net loss                                $ (366)       $ (9)       $ (614)      $ (192)

Net loss allocated to general
  partners (2%)                          $ (7)        $ --        $ (12)        $ (4)
Net loss allocated to limited
  partners (98%)                           (359)          (9)        (602)        (188)

                                        $ (366)       $ (9)       $ (614)      $ (192)

Net loss per limited partnership
  unit                                 $(354.92)    $ (8.90)     $(595.16)    $(185.86)

            See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>


c)

                     DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

               CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT
                                   (Unaudited)
                          (in thousands, except unit data)

<TABLE>
<CAPTION>


                                     Limited
                                     Partnership     General      Limited
                                        Units        Partners    Partners     Total

<S>                                    <C>             <C>        <C>        <C>
Original capital contributions         1,013.0         $ 1        $20,240    $20,241

Partners' deficit at
   December 31, 2000                   1,011.5        $ (134)     $(6,574)   $(6,708)

Net loss for the six months
   ended June 30, 2001                      --           (12)        (602)      (614)

Partners' deficit at
   June 30, 2001                       1,011.5        $ (146)     $(7,176)   $(7,322)

            See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>


d)

                     DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                   (in thousands)
<TABLE>
<CAPTION>

                                                                    Six Months Ended
                                                                        June 30,
                                                                    2001         2000
Cash flows from operating activities:
<S>                                                                <C>          <C>
  Net loss                                                         $ (614)      $ (192)
  Adjustments to reconcile net loss to net cash
   provided by operating activities:
     Depreciation                                                      864          797
     Amortization of mortgage discounts and loan costs                  33           32
     Change in accounts:
      Receivables and deposits                                         (31)          (7)
      Other assets                                                     (73)         (47)
      Accounts payable                                                  (5)         (26)
      Tenant security deposit liabilities                              (19)          12
      Accrued property taxes                                            89           47
      Other liabilities                                                157         (104)
      Due to affiliate                                                  31            2
         Net cash provided by operating activities                     432          514

Cash flows from investing activities:
  Property improvements and replacements                              (576)        (347)
  Net deposits to restricted escrows                                   (57)         (68)
         Net cash used in investing activities                        (633)        (415)

Cash flows from financing activities:
  Payments on mortgage notes payable                                   (73)         (69)
  Advances from affiliates                                              72           73
  Payments on advances from affiliates                                 (38)          --
         Net cash (used in) provided by financing activities           (39)           4

Net (decrease) increase in cash and cash equivalents                  (240)         103
Cash and cash equivalents at beginning of period                       459          480

Cash and cash equivalents at end of period                          $ 219        $ 583

Supplemental disclosure of cash flow information:
  Cash paid for interest                                           $ 1,038      $ 1,041

Included in property improvements and replacements for the six months ended June
30, 2001 are  approximately  $240,000  of  improvements  which were  included in
accounts payable at December 31, 2000.

            See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>

e)

                     DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

Note A - Basis of Presentation

The  accompanying   unaudited  consolidated  financial  statements  of  Davidson
Diversified Real Estate III, L.P. (the  "Partnership" or "Registrant") have been
prepared in accordance with generally accepted accounting principles for interim
financial  information and with the  instructions to Form 10-QSB and Item 310(b)
of Regulation S-B.  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 Davidson Diversified  Properties,  Inc.
(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,
2001 are not necessarily  indicative of the results that may be expected for the
year  ending  December  31,  2001.  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, 2000.
The  Managing  General  Partner  is  a  wholly  owned  subsidiary  of  Apartment
Investment  and  Management  Company  ("AIMCO"),  a publicly  traded real estate
investment trust.

Principles of Consolidation

The financial  statements include all of the accounts of the Partnership and its
99.9% limited partnership interest in Plainview Apartments,  L.P. and its wholly
owned Limited Liability Corporation, Salem GP, LLC. The Managing General Partner
of the consolidated  partnership is Davidson Diversified Properties,  Inc. which
may be removed as the Managing General Partner of the  consolidated  partnership
by the Registrant;  therefore,  the  consolidated  partnership is controlled and
consolidated by the Registrant.  All significant  interpartnership balances have
been eliminated.

Reclassifications

Certain  of the 2000  balances  have been  reclassified  to  conform to the 2001
presentation.

Segment Reporting

Statement of Financial  Accounting Standards ("SFAS") No. 131, "Disclosure about
Segments of an Enterprise and Related Information" established standards for the
way that public business enterprises report information about operating segments
in annual  financial  statements  and  required  that those  enterprises  report
selected  information about operating segments in interim financial reports.  It
also established  standards for related disclosures about products and services,
geographic  areas,  and  major  customers.  As  defined  in SFAS  No.  131,  the
Partnership  has only one  reportable  segment.  The  Managing  General  Partner
believes that  segment-based  disclosures  will not result in a more  meaningful
presentation than the consolidated financial statements as currently presented.

Note B - Transactions with Affiliated Parties

The  Partnership  has no employees  and is  dependent  on the  Managing  General
Partner  and  its  affiliates  for  the  management  and  administration  of all
Partnership  activities.  The  Partnership  Agreement  provides  for (i) certain
payments to affiliates for services and (ii)  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, 2001 and 2000:

                                                         2001       2000
                                                          (in thousands)
         Property management fees (included in
           operating expenses)                           $155       $154
         Reimbursement for services of affiliates
           (included in general and administrative
            expenses and investment properties)            91         57

Affiliates of the Managing  General  Partner are entitled to receive 5% of gross
receipts  from both of the  Registrant's  investment  properties  for  providing
property   management   services.   The  Registrant   paid  to  such  affiliates
approximately  $155,000  and $154,000 for the six months ended June 30, 2001 and
2000, respectively.

An  affiliate  of  the  Managing  General  Partner  received   reimbursement  of
accountable  administrative  expenses  amounting  to  approximately  $91,000 and
$57,000 for the six months ended June 30, 2001 and 2000,  respectively.  At June
30, 2001,  approximately  $45,000 of reimbursements  for services was accrued by
the  Partnership  and  is  included  in due to  affiliates  on the  accompanying
consolidated balance sheet.

During the six months ended June 30, 2001, the Managing General Partner advanced
the Partnership  approximately $72,000 to cover operational expenses required at
Salem  Courthouse.  This  loan was  made in  accordance  with  the  terms of the
Partnership  Agreement.  At June 30,  2001,  the balance of the loan,  including
accrued interest,  was approximately  $73,000.  Interest is charged at the prime
rate plus 1%. During the six months ended June 30, 2001, the Partnership  repaid
advances of  approximately  $38,000.  During the six months ended June 30, 2000,
the Managing General Partner advanced the Partnership  approximately  $73,000 to
cover operational expenses required at Plainview Apartments.

In addition to its  indirect  ownership of the general  partner  interest in the
Partnership,  AIMCO and its affiliates  owned 382.50 limited  partnership  units
(the "Units") in the Partnership representing 37.82% of the outstanding Units at
June 30, 2001. 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  make  one  or  more  additional  offers  to  acquire   additional  limited
partnership  interests in the  Partnership  for cash or in exchange for units in
the operating partnership of AIMCO. Under the Partnership Agreement, unitholders
holding a majority of the Units are  entitled  to take action with  respect to a
variety of matters,  which would include without  limitation,  voting on certain
amendments  to the  Partnership  Agreement  and  voting to remove  the  Managing
General Partner. When voting on matters,  AIMCO would in all likelihood vote the
Units it acquired in a manner  favorable to the interest of the Managing General
Partner because of its affiliation with the Managing General Partner.

Note C - 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. 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  purports to assert claims on
behalf of a class of limited  partners and derivatively on behalf of a number of
limited  partnerships  (including  the  Partnership)  which are named as nominal
defendants,  challenging,  among other things,  the  acquisition of interests in
certain general partner entities by Insignia Financial Group, Inc.  ("Insignia")
and entities which 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
seek monetary damages and equitable relief,  including  judicial  dissolution of
the  Partnership.  On June 25, 1998, the Managing General Partner filed a motion
seeking  dismissal  of the action.  In lieu of  responding  to the  motion,  the
plaintiffs  filed an amended  complaint.  The  Managing  General  Partner  filed
demurrers to the amended complaint which were heard February 1999.

Pending the ruling on such  demurrers,  settlement  negotiations  commenced.  On
November 2, 1999,  the parties  executed and filed a Stipulation  of Settlement,
settling claims, subject to court approval, on behalf of the Partnership and all
limited partners who owned units as of November 3, 1999. Preliminary approval of
the  settlement  was obtained on November 3, 1999 from the Court,  at which time
the Court set a final  approval  hearing for  December  10,  1999.  Prior to the
December  10,  1999  hearing,  the  Court  received  various  objections  to the
settlement, including a challenge to the Court's preliminary approval based upon
the alleged lack of authority of prior lead counsel to enter the settlement.  On
December 14, 1999, the Managing  General  Partner and its affiliates  terminated
the  proposed  settlement.  In  February  2000,  counsel  for some of the  named
plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who
negotiated  the  settlement.  On June  27,  2000,  the  Court  entered  an order
disqualifying  them  from the case and an  appeal  was  taken  from the order on
October 5, 2000. On December 4, 2000, the Court  appointed the law firm of Lieff
Cabraser  Heimann & Bernstein  LLP as new lead  counsel for  plaintiffs  and the
putative class.  Plaintiffs filed a third amended complaint on January 19, 2001.
On March 2, 2001,  the  Managing  General  Partner  and its  affiliates  filed a
demurrer to the third amended  complaint.  On May 14, 2001,  the Court heard the
demurrer to the third amended  complaint.  On July 10, 2001, the Court issued an
order sustaining defendants' demurrer on certain grounds.  Plaintiffs have until
August 16, 2001 to file a fourth amended complaint. The Managing General Partner
does  not  anticipate  that  any  costs,  whether  legal  or  settlement  costs,
associated  with  this  case  will  be  material  to the  Partnership's  overall
operations.

The  Partnership is unaware of any other pending or outstanding  litigation that
is not of a routine nature arising in the ordinary course of business.



<PAGE>




ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATIONS

The  matters  discussed  in this Form  10-QSB  contain  certain  forward-looking
statements  and  involve  risks and  uncertainties  (including  changing  market
conditions,   competitive  and  regulatory   matters,   etc.)  detailed  in  the
disclosures  contained  in this  Form  10-QSB  and the  other  filings  with the
Securities and Exchange Commission made by the Registrant from time to time. The
discussion of the  Registrant's  business and results of  operations,  including
forward-looking  statements  pertaining  to such  matters,  does not  take  into
account the effects of any changes to the  Registrant's  business and results of
operation.  Accordingly,  actual  results  could  differ  materially  from those
projected in the forward-looking  statements as a result of a number of factors,
including those identified herein.

The Partnership's  investment properties consist of two apartment complexes. The
following table sets forth the average occupancy of these properties for the six
months ended June 30, 2001 and 2000:

                                                 Average Occupancy
                                                 2001        2000
         Salem Courthouse
            Indianapolis, Indiana                 94%         93%
         Plainview Apartments
            Louisville, Kentucky                  84%         96%

Occupancy at Plainview Apartments has decreased due to a softening market and an
increase in competition from newer properties.

Results of Operations

The  Registrant's  net  loss  for  the  six  months  ended  June  30,  2001  was
approximately  $614,000 as compared to a net loss of approximately  $192,000 for
the same period in 2000.  The  Registrant's  net loss for the three months ended
June  30,  2001  was  approximately  $366,000  as  compared  to a  net  loss  of
approximately  $9,000 for the same period in 2000.  The increase in net loss for
both the three and six months ended June 30, 2001 is primarily attributable to a
decrease in total  revenues and an increase in total  expenses.  The decrease in
total  revenues is due to a decrease  in rental  income  partially  offset by an
increase in other income.  Rental income decreased primarily due to the decrease
in occupancy at Plainview Apartments offset by increases in average rental rates
at both  properties.  The increase in other income is primarily due to increases
in tenant reimbursements and late charges at Plainview.

The increase in total  expenses is due to increases in operating,  depreciation,
property tax and general and administrative  expenses. The increase in operating
expense is  primarily  attributable  to an  increase  in  utilities,  especially
natural  gas.  Depreciation  expense  increased  due to an  increase in property
improvements and replacements  during the last twelve months at both properties.
Property tax expense  increased due to an increase in the assessed values by the
local  taxing  authorities  and due to receipt of a property tax refund at Salem
Courthouse in 2000.

General  and   administrative   expenses   increased   due  to  an  increase  in
reimbursements  to the Managing  General  Partner  allowed under the Partnership
Agreement associated with its management of the Partnership.  In addition, costs
associated  with the  quarterly  and annual  communications  with  investors and
regulatory  agencies and the annual audit required by the Partnership  Agreement
are also included in general and administrative expenses.

As part of the ongoing  business plan of the  Partnership,  the Managing General
Partner monitors the rental market  environment of its investment  properties 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,  due to changing  market
conditions,  which  can  result  in the use of  rental  concessions  and  rental
reductions to offset softening market conditions, there is no guarantee that the
Managing General Partner will be able to sustain such a plan.

Liquidity and Capital Resources

At June 30, 2001, the Registrant had cash and cash  equivalents of approximately
$219,000 as compared to  approximately  $583,000 at June 30, 2000. Cash and cash
equivalents decreased  approximately  $240,000 for the six months ended June 30,
2001 from the  Registrant's  year ended  December  31,  2000.  This  decrease is
primarily  due to  approximately  $633,000 and $39,000 of cash used in investing
and  financing   activities,   respectively,   which  is  partially   offset  by
approximately  $432,000 of cash provided by operating  activities.  Cash used in
investing activities consisted of property improvements and replacements and, to
a lesser  extent,  net deposits to escrow  accounts  maintained  by the mortgage
lender. Cash used in financing  activities  consisted of principal payments made
on the mortgages  encumbering  the  investment  properties  and the repayment of
advances from the Managing General Partner offset partially by advances from the
Managing General Partner. The Registrant invests its working capital reserves 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  properties  to  adequately  maintain the physical
assets and other  operating  needs of the Registrant and to comply with Federal,
state, and local legal and regulatory requirements. Capital improvements planned
for both of the Registrant's properties are detailed below.

Plainview  Apartments:  The  Partnership  budgeted  approximately  $132,000  for
capital improvements during 2001 at Plainview Apartments consisting primarily of
interior  and  exterior  building   improvements.   The  Partnership   completed
approximately  $101,000 in capital  expenditures at Plainview  Apartments during
the six months  ended June 30,  2001,  consisting  primarily  of heating and air
conditioning  upgrades,  floor  covering,  water  heater  and  plumbing  fixture
replacements,  and structural improvements.  These improvements were funded from
operating cash flow.  Additional  improvements may be considered and will depend
on the  physical  condition  of the  property as well as  anticipated  cash flow
generated by the property.

Salem Courthouse Apartments: The Partnership budgeted approximately $211,000 for
capital  improvements  during 2001 at Salem Courthouse  consisting  primarily of
interior  and  exterior  building   improvements.   The  Partnership   completed
approximately  $235,000 in budgeted and  non-budgeted  capital  expenditures  at
Salem  Courthouse  Apartments  during  the  six  months  ended  June  30,  2001,
consisting  primarily of perimeter fencing,  exterior building  painting,  floor
covering  replacements  and structural  improvements.  These  improvements  were
funded from operating cash flow.  Additional  improvements may be considered and
will depend on the physical  condition  of the  property as well as  replacement
reserves and anticipated cash flow generated by the property.

The additional  capital  expenditures will be incurred only if cash is available
from operations or from Partnership  reserves.  To the extent that such budgeted
capital improvements are completed, the Registrant's distributable cash flow, if
any, may be adversely affected at least in the short term.

The  Registrant's  current assets are thought to be sufficient for any near-term
needs  (exclusive  of capital  improvements)  of the  Registrant.  The  mortgage
indebtedness of approximately  $23,449,000,  net of discount,  is amortized over
360 months  with a balloon  payment of  approximately  $23,120,000  due at dates
ranging from October 15, 2003 to November 15, 2010. The Managing General Partner
will attempt to refinance such indebtedness  and/or sell the properties prior to
such  maturity  dates.  If the  properties  cannot be  refinanced  or sold for a
sufficient  amount,  the  Registrant  will risk losing such  properties  through
foreclosure.

The  Partnership did not make any  distributions  to its partners during the six
month periods ended June 30, 2001 or 2000. Future cash distributions will depend
on the levels of net cash generated from  operations,  the  availability of cash
reserves,  and the timing of the debt maturities,  refinancings  and/or property
sales. The Partnership's  distribution  policy is reviewed on a quarterly basis.
There can be no assurance that the  Registrant  will generate  sufficient  funds
from operations  after planned capital  expenditures to permit  distributions to
its partners during the remainder of 2001 or subsequent  periods.  Distributions
may be  restricted  by the  requirements  to deposit  net  operating  income (as
defined in the mortgage note) into the reserve account until the reserve account
is  funded in an amount  equal to a  minimum  of $200 and a maximum  of $400 per
apartment  unit for Salem  Courthouse  Apartments  for a total of  approximately
$78,000  to  $155,000.  The  reserve  account  balance  at  June  30,  2001  was
approximately $136,000.

In addition to its  indirect  ownership of the general  partner  interest in the
Partnership,  AIMCO and its affiliates  owned 382.50 limited  partnership  units
(the "Units") in the Partnership representing 37.82% of the outstanding Units at
June 30, 2001. 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  make  one  or  more  additional  offers  to  acquire   additional  limited
partnership  interests in the  Partnership  for cash or in exchange for units in
the operating partnership of AIMCO. Under the Partnership Agreement, unitholders
holding a majority of the Units are  entitled  to take action with  respect to a
variety of matters,  which would include without  limitation,  voting on certain
amendments  to the  Partnership  Agreement  and  voting to remove  the  Managing
General Partner. When voting on matters,  AIMCO would in all likelihood vote the
Units it acquired in a manner  favorable to the interest of the Managing General
Partner because of its affiliation with the Managing General Partner.


<PAGE>


                           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. 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  purports to assert claims on
behalf of a class of limited  partners and derivatively on behalf of a number of
limited  partnerships  (including  the  Partnership)  which are named as nominal
defendants,  challenging,  among other things,  the  acquisition of interests in
certain general partner entities by Insignia Financial Group, Inc.  ("Insignia")
and entities which 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
seek monetary damages and equitable relief,  including  judicial  dissolution of
the  Partnership.  On June 25, 1998, the Managing General Partner filed a motion
seeking  dismissal  of the action.  In lieu of  responding  to the  motion,  the
plaintiffs  filed an amended  complaint.  The  Managing  General  Partner  filed
demurrers to the amended complaint which were heard February 1999.

Pending the ruling on such  demurrers,  settlement  negotiations  commenced.  On
November 2, 1999,  the parties  executed and filed a Stipulation  of Settlement,
settling claims, subject to court approval, on behalf of the Partnership and all
limited partners who owned units as of November 3, 1999. Preliminary approval of
the  settlement  was obtained on November 3, 1999 from the Court,  at which time
the Court set a final  approval  hearing for  December  10,  1999.  Prior to the
December  10,  1999  hearing,  the  Court  received  various  objections  to the
settlement, including a challenge to the Court's preliminary approval based upon
the alleged lack of authority of prior lead counsel to enter the settlement.  On
December 14, 1999, the Managing  General  Partner and its affiliates  terminated
the  proposed  settlement.  In  February  2000,  counsel  for some of the  named
plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who
negotiated  the  settlement.  On June  27,  2000,  the  Court  entered  an order
disqualifying  them  from the case and an  appeal  was  taken  from the order on
October 5, 2000. On December 4, 2000, the Court  appointed the law firm of Lieff
Cabraser  Heimann & Bernstein  LLP as new lead  counsel for  plaintiffs  and the
putative class.  Plaintiffs filed a third amended complaint on January 19, 2001.
On March 2, 2001,  the  Managing  General  Partner  and its  affiliates  filed a
demurrer to the third amended  complaint.  On May 14, 2001,  the Court heard the
demurrer to the third amended  complaint.  On July 10, 2001, the Court issued an
order sustaining defendants' demurrer on certain grounds.  Plaintiffs have until
August 16, 2001 to file a fourth amended complaint. The Managing General Partner
does  not  anticipate  that  any  costs,  whether  legal  or  settlement  costs,
associated  with  this  case  will  be  material  to the  Partnership's  overall
operations.

ITEM 6      EXHIBITS AND REPORTS ON FORM 8-K

            a)    Exhibits

                  None.

            b)    Reports on Form 8-K:

                  None filed during the quarter ended June 30, 2001.

<PAGE>


                                   SIGNATURES



In accordance with the  requirements of the Exchange Act, the registrant  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


                                    By:   /s/Patrick J. Foye
                                          Patrick J. Foye
                                          Executive Vice President


                                    By:   /s/Martha L. Long
                                          Martha L. Long
                                          Senior Vice President and
                                          Controller


                                    Date: