<PAGE>
 
                                    FORM 10-K
                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

(Mark One)
[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

         For the fiscal year ended     December  31, 1998
                                       ------------------      
                                      OR

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

         For the transition period from____________________to_______________

                         Commission file number 0-20253

                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
             (Exact name of registrant as specified in its charter)

          Wisconsin                                      39-1660958
(State or other jurisdiction of                       (I.R.S. Employer
incorporation or organization)                        Identification No.)

            101 W. 11th St., Suite 1110, Kansas City, Missouri 64105
          (Address of principal executive offices, including zip code)

                                 (816) 421-7444
              (Registrant's telephone number, including area code)

(Former  name,  former  address and former  fiscal year,  if changed  since last
report.)

Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:  Limited Partnership
                                                             Interests

         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 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

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

         The  aggregate   market  value  of  the  voting   securities   held  by
nonaffiliates  of  the  Registrant:   The  aggregate  market  value  of  limited
partnership  interests held by nonaffiliates is not determinable  since there is
no public trading market for the limited partnership interests.

                   Index to Exhibits located on page: 30 - 31
                                                      -------
                                     PART I
<PAGE>
 
Item 1.  Business

Background

The   Registrant,   DiVall  Income   Properties  3  Limited   Partnership   (the
"Partnership"),  is a limited partnership  organized under the Wisconsin Uniform
Limited Partnership Act pursuant to an Agreement of Limited Partnership dated as
of December  12, 1989,  and amended as of December 18, 1989,  February 19, 1990,
April 9, 1990,  February 8, 1993, May 26, 1993,  June 1, 1993, and June 30, 1994
(collectively  the  "Partnership  Agreement").  As of  December  31,  1998,  the
Partnership  consisted of one General Partner and 1,092 Limited  Partners owning
an aggregate of 17,102.52 Limited  Partnership  D-Interests (the  "D-Interests")
acquired  at a public  offering  price of  $1,000  per  Interest  before  volume
discounts.  The Interests were sold pursuant to a Registration Statement on Form
S-11 filed under the  Securities  Act of 1933 dated April 23, 1990. On April 23,
1992,   the   Partnership   closed  the   offering  at  17,102.52  D-  Interests
($17,102,520),  providing net proceeds to the Partnership after volume discounts
and offering costs of $14,408,872.

The Partnership is currently engaged in the business of owning and operating its
investment   portfolio  (the   "Properties")  of  commercial  real  estate.  The
Properties are leased on a triple net basis to, and operated by,  franchisors or
franchisees  of  national,  regional and local  retail  chains  under  long-term
leases.  The  lessees  consist of  fast-food,  family  style,  and  casual/theme
restaurants. At December 31, 1998, the Partnership owned five (5) Properties and
specialty leasehold  improvements for use in all five (5) of the Properties,  as
more fully  described in Item 2. During the Second  Quarter of 1998, the General
Partner  received the written  consent of a majority of the Limited  Partners to
liquidate the Partnership's  assets and dissolve the Partnership.  Management is
currently  seeking a  purchaser  for the  Partnership's  Properties  within  the
parameters  of this  consent.  However,  management  expects to continue  normal
operations for the Partnership for the foreseeable future.

The  Partnership's  return on its investment  will be derived  principally  from
rental payments received from its lessees.  Therefore,  the Partnership's return
on its investment is largely  dependent upon, among other factors,  the business
success of its lessees.  The business  success of the  Partnership's  individual
lessees can be adversely  affected on three general levels.  First,  the tenants
rely  heavily  on the  management  contributions  of a few  key  entrepreneurial
owners. The business operations of such entrepreneurial tenants can be adversely
affected by death, disability or divorce of a key owner, or by such owner's poor
business  decisions  such as an  undercapitalized  business  expansion.  Second,
changes  in a local  market  area  can  adversely  affect  a  lessee's  business
operation.  A local  economy  can  suffer a  downturn  with  high  unemployment.
Socioeconomic  neighborhood  changes can affect retail demand at specific  sites
and traffic  patterns may change,  or stronger  competitors  may enter a market.
These and other  local  market  factors  can  potentially  adversely  affect the
lessees of Partnership properties. Finally, despite an individual lessee's solid
business  plans in a strong local market,  the chain  concept  itself can suffer
reversals  or  changes  in  management  policy  which  can in  turn  affect  the
profitability of operations for Partnership properties.  Therefore, there can be
no assurance that any specific lessee will have the ability to pay its rent over
the entire term of its lease with the Partnership.

Since all of the Partnership's  investment in properties and equipment  involves
restaurant  tenants,  the  restaurant  market is the major market segment with a
material impact on Partnership operations. It would

                                       2
<PAGE>
 
appear that the management skill and potential operating  efficiencies  realized
by Partnership  lessees will be a major  ingredient  for their future  operating
success in a very competitive restaurant and food service marketplace.

There is no way to determine with any  certainty,  which,  if any,  tenants will
succeed or fail in their business  operations over the term of their  respective
leases with the Partnership.  It can be reasonably anticipated that some lessees
will default on future lease  payments to the  Partnership  which will result in
the loss of expected lease income for the  Partnership.  Management will use its
best efforts to vigorously  pursue  collection  of any defaulted  amounts and to
protect the Partnership  assets and future rental income  potential by trying to
re-lease any Properties with rental defaults. External events which could impact
the  Partnership's  liquidity  are the  entrance of other  competitors  into the
market  areas  of our  tenants;  liquidity  and  working  capital  needs  of the
leaseholders;  and failure or withdrawal of any of the national  franchises held
by the  Partnership's  tenant.  Each of these events,  alone or in  combination,
would affect the liquidity level of leaseholders  resulting in possible  default
by the tenant.  Since the information  regarding plans for future  liquidity and
expansion of closely held  organizations,  which are tenants of the Partnership,
tends to be of a private and  proprietary  nature,  anticipation  of  individual
liquidity  problems is  difficult,  and  prediction  of future  events is nearly
impossible.

A preliminary  investigation  during 1992 by the Office of the  Commissioner  of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the  "Investigation"),  revealed  that  during at least the three  years  ended
December 31, 1992, two of the former general partners of the  Partnership,  Gary
J.  DiVall  ("DiVall")  and  Paul  E.  Magnuson   ("Magnuson")  had  transferred
substantial  cash  assets  of  the  Partnership  and  two  affiliated   publicly
registered partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall
1") and DiVall  Insured  Income  Properties 2 Limited  Partnership  ("DiVall 2")
(collectively the "Partnerships") to various other entities previously sponsored
by or otherwise affiliated with DiVall and Magnuson.  The unauthorized transfers
were in violation of the respective Partnership Agreements.

Subsequent  to  discovery,  and in  response  to  the  regulatory  inquiries,  a
third-party  Permanent  Manager,  The Provo Group, Inc.  ("TPG"),  was appointed
(effective  February 8, 1993) to assume the  responsibility for daily operations
and  assets of the  Partnerships  as well as to  develop  and  execute a plan of
restoration to the Partnerships. As reported in the Partnership's report on Form
8-K dated May 26, 1993,  effective  as of that date,  the Limited  Partners,  by
written consent of a majority of interests,  elected the Permanent Manager, TPG,
as General Partner. Additional results of the solicitation included the approval
of the Permanent Manager Agreement  ("PMA"),  the acceptance of the resignations
of  the  former  general  partners,  amendments  to  certain  provisions  of the
Partnership  Agreement pertaining to general partner interests and compensation,
and an amendment of the  Partnership  Agreement  providing for an Advisory Board
(the "Board").

The Permanent Manager Agreement

The PMA was entered into on February 8, 1993, between the Partnership,  DiVall 1
(which  was  dissolved  in  December  1998),  DiVall 2, the now  former  general
partners DiVall and Magnuson,  their controlled affiliates,  and TPG, naming TPG
as the Permanent  Manager.  The PMA contains  provisions  allowing the Permanent
Manager  to submit  the PMA,  the issue of  electing  the  Permanent  Manager as
General  Partner,  and the issue of acceptance of the resignations of the former
general  partners to a vote of the Limited  Partners  through a solicitation  of
written consents.

                                       3
<PAGE>
 
TPG, as the new General Partner,  has been operating and managing the affairs of
the Partnership in accordance with the provisions of the PMA and the Partnership
Agreement.

Advisory Board

The  concept  of the  Advisory  Board was first  introduced  by TPG  during  the
solicitation of written consents for the  Partnerships,  and is the only type of
oversight body known to exist for similar  partnerships  at this time. The first
Advisory  Board was  appointed in October  1993,  and held its first  meeting in
November  1993.  The three person  Advisory  Board is empowered  to, among other
functions,  review  operational  policies and  practices,  review  extraordinary
transactions,  and advise and serve as an audit committee to the Partnership and
the General  Partner.  The Advisory  Board does not have the authority to direct
management  decisions  or  policies  of the  Partnership  or remove the  General
Partner.  The powers of the Advisory Board are advisory only. The Advisory Board
has full and free access to the Partnership's books and records,  and individual
Advisory Board members have the right to  communicate  directly with the Limited
Partners  concerning  Partnership  business.  Members of the Advisory  Board are
compensated $3,000 annually and $1,200 for each quarterly meeting attended.

The Advisory Board currently consists of a broker dealer representative,  Steven
Carson;  and a  Limited  Partner  from each of the two  remaining  Partnerships:
Richard Otte from DiVall 2 and Albert Gerritz from the Partnership.  For a brief
description  of each  Advisory  Board  member,  refer to Item 10,  Directors and
Executive Officers of the Registrant.

The Partnership has no employees.

All of the Partnership's business is conducted in the United States.

Item 2.  Properties

The  Partnership's  Properties  are leased under 20 year leases.  All leases are
triple  net  which  require  the  tenant  to pay all  property  operating  costs
including maintenance,  repairs,  utilities,  property taxes, and insurance. All
leases  contain  percentage  rent  provisions  which require the tenant to pay a
specified percentage (3% to 7%) of gross sales above a threshold amount.

The Partnership owned the following  Properties  (including  specialty leasehold
improvements) as of December 31, 1998:
<TABLE>
<CAPTION>



                                                                                           Lease
Acquisi-      Property Name                                Purchase         Rental Per     Expiration     Renewal
tion Date     & Address               Lessee               Price (1)        Annum          Date           Options
---------     ---------               ------               ---------        -----          ----           -------
<S>           <C>                     <C>                 <C>              <C>           <C>               <C>             
08/14/90      Hardee's                Hardee's Food       1,648,569(2)     92,000        01/31/2010        None
              2450 E Layton Ave       Systems, Inc.
              St Francis, WI
09/11/90      Applebee's              B.T. Woodlipp,      1,297,990(2)    116,040        11/30/2009        None
              2101 Greentree Rd       Inc.
              Pittsburgh, PA

</TABLE>

                                       4
<PAGE>
 
<TABLE>
<CAPTION>


                                                                                            Lease
Acquisi-      Property Name                                 Purchase         Rental Per     Expiration     Renewal
tion Date     & Address                Lessee               Price (1)        Annum          Date           Options
---------     ---------                ------               ---------        -----          ----           -------
<S>           <C>                      <C>                  <C>                <C>        <C>                 <C>               
02/05/91      Hardee's                 Hardee's Food        1,929,472(2)       88,000     05/31/2010          None
              9505 S 13th St           Systems, Inc.
              Oak Creek, WI
07/01/91      Denny's                  DenAmerica, Inc.       424,187(2)       35,880     06/30/2011          None
              9060 Arapahoe Rd
              Englewood, CO
04/28/92      Denny's                  DenAmerica, Inc.       791,159(2)       77,460     05/31/2012           (3)
                                                              ----------       ------
              4375 Sinton Rd
              Colorado Springs, CO

                                                           $6,091,377       $409,380
                                                           ==========       ========
</TABLE>


Footnotes.

(1) Purchase price includes all costs incurred to acquire the property.
(2) Purchase price includes cost of specialty leasehold improvements.
(3) Renewal options available.


In connection with the proposed liquidation of the Partnership,  appraisals were
received on all of the Partnership's  Properties.  The two Hardee's were written
down to their estimated net realizable values based on the appraisals  received.
The write-downs approximated $400,000.

During 1997, the Partnership sold its Hardee's  property in Wahoo,  Nebraska for
approximately  $405,000,  resulting  in a  gain,  before  disposition  fees,  of
approximately $8,000.

During  January  1998,  the  Partnership  sold its Denny's  property in Sanford,
Florida to the tenant for $1,250,000,  resulting in a gain,  before  disposition
fees, of approximately $240,000.

Item 3.  Legal Proceedings

None.

Item 4.  Submission of  Matters to a Vote of Security Holders

None.
                                     PART II

Item 5.  Market Price and Dividends on Registrant's Common Equity and Related
Stockholder Matters

(a)      Although  some  Interests  have been traded,  there is no active public
         market  for the  Interests  and it is not  anticipated  that an  active
         public market for the Interests will develop.

(b)      As of December 31, 1998,  there were 1,092 record  holders of Interests
         in the Partnership.

                                       5
<PAGE>
 
(c)      The  Partnership  does  not pay  dividends.  However,  the  Partnership
         Agreement   provides  for   distributable  net  cash  receipts  of  the
         Partnership to be  distributed on a quarterly or monthly basis,  99% to
         the  Limited  Partners  and 1% to the General  Partner,  subject to the
         limitations on  distributions  to the General Partner  described in the
         Partnership Agreement. During 1998 and 1997, $1,745,000 and $1,650,000,
         respectively,   were  distributed  in  the  aggregate  to  the  Limited
         Partners.  In 1998 and 1997,  the General  Partner  received  aggregate
         distributions of $1,325 and $2,418, respectively.


Item 6.  Selected Financial Data


                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
                        (a Wisconsin limited partnership)

                  December 31, 1998, 1997, 1996, 1995, and 1994
                  (not covered by Independent Auditors' Report)
<TABLE>
<CAPTION>


----------------------------------------------------------------------------------------------------
                                1998            1997           1996           1995           1994
----------------------------------------------------------------------------------------------------
<S>                         <C>             <C>            <C>            <C>            <C>        
Total Revenue               $   698,995     $   939,210    $ 1,812,164    $   951,189    $ 1,079,845
----------------------------------------------------------------------------------------------------
Net Income
(Loss)                          (68,993)        604,505        697,472         20,425        385,971
----------------------------------------------------------------------------------------------------
Net Income
(Loss) per
Limited Partner
Interest                          (3.99)          34.99          40.37           1.18          22.34
----------------------------------------------------------------------------------------------------
Total Assets                  3,685,808       5,543,931      6,720,437      8,001,587      8,723,385
----------------------------------------------------------------------------------------------------
Total Partners'
Capital                       3,622,874       5,438,132      6,486,045      7,441,362      8,155,826
----------------------------------------------------------------------------------------------------
Cash
Distributions
per Limited
Partnership
Interest                         102.03           96.48          96.48          42.98         123.24
----------------------------------------------------------------------------------------------------
</TABLE>

(a)      The above selected  financial  data should be read in conjunction  with
         the financial  statements and the related notes appearing  elsewhere in
         this annual report.




                                       6
<PAGE>
 
Item 7.  Management's  Discussion  and Analysis of Financial  Condition  and
         Results of Operations

Liquidity and Capital Resources:

Investment Properties and Net Investment in Direct Financing Leases

The  Properties,  including  equipment  held by the  Partnership at December 31,
1998,  were originally  purchased at a price,  including  acquisition  costs, of
approximately $6,091,000.

During 1997, the Partnership sold its Hardee's  property in Wahoo,  Nebraska for
approximately  $405,000,  resulting  in a  gain,  before  disposition  fees,  of
approximately $8,000.

During 1998, the Partnership sold its Denny's property in Sanford,  Florida,  to
the  tenant for  $1,250,000,  resulting  in a gain  before  disposition  fees of
approximately $240,000.

Other Assets

Cash and cash equivalents held by the Partnership, were $231,000 at December 31,
1998, compared to $595,000 at December 31, 1997. The Partnership designated cash
of $60,000 to fund the Fourth  Quarter 1998  distributions  to Limited  Partners
paid in February 1999;  $46,000 for the payment of year-end accounts payable and
accrued  expenses;  and the remainder  represents  reserves deemed  necessary to
allow the  Partnership  to operate  normally.  The decrease is primarily  due to
recoveries  received  during the Fourth Quarter of 1997,  which was  distributed
during the First Quarter of 1998.  Cash generated  through the operations of the
Partnership's  Properties,  and sales of Properties will provide the sources for
future fund liquidity and Limited Partner distributions.

The Partnership  established an  Indemnification  Trust (the "Trust") during the
Fourth Quarter of 1993 and deposited $130,000 in the Trust during 1994, $100,000
during 1995 and $20,000  during 1996.  The  provision to establish the Trust was
included in the Permanent Manager Agreement for the  indemnification  of TPG, in
the absence of fraud or gross  negligence,  from any claims or liabilities  that
may  arise  from TPG  acting  as  Permanent  Manager.  The Trust is owned by the
Partnership.  For additional information regarding the Trust, refer to Note 8 to
the financial statements included in Item 8 of this report.

Liabilities

Accounts  payable and accrued  expenses at December 31,  1998,  in the amount of
$19,000, primarily represented accruals of legal and auditing fees.

Security  deposits  decreased  from $37,000 at December 31, 1997,  to $17,000 at
December 31, 1998, due to the application of the security deposit on the Denny's
property in Florida to the purchase price of the property.


                                       7
<PAGE>
 
Partners' Capital

Net  income for the year was  allocated  between  the  General  Partner  and the
Limited  Partners,  1% and 99%,  respectively,  as provided  in the  Partnership
Agreement as discussed more fully in Note 4 of the financial statements included
in Item 8 of this report.  The former general  partners' capital account balance
was reallocated to the Limited Partners at December 31, 1993. Refer to Note 9 to
the  financial  statements  included  in Item 8 of this  report  for  additional
information regarding the reallocation.

Cash  distributions  paid to the Limited  Partners  and to the  General  Partner
during 1998,  of  $1,745,000  and $1,325,  respectively,  have also been made in
accordance with the Partnership Agreement.  The Fourth Quarter 1998 distribution
of $60,000 was paid to the Limited Partners on February 15, 1999.

Results of Operations:

The Partnership reported a net loss for the year ended December 31, 1998, in the
amount of $69,000  compared to net income for the years ended  December 31, 1997
and 1996 of $605,000 and  $697,000.  Results for all three years were  different
than would be expected  from  "normal"  operations,  primarily  because of costs
associated with  misappropriation  of assets by the former general  partners and
their affiliates,  non-cash write-offs of uncollectible rent and equipment lease
losses,  the  write-down  of  Properties  to their net  realizable  values,  and
property  valuation  costs. In addition,  1996 and 1997 results were impacted by
the reversal of a portion of the former general  partner  receivable  write-off,
and 1998 was impacted by a gain on the sale of the Florida Denny's Property.

Revenues

Total  revenues were $699,000,  $939,000,  and  $1,812,000,  for the years ended
December 31, 1998,  1997,  and 1996,  respectively.  Revenue in 1996  included a
$1,000,000  reversal of a prior year  write-off  of the former  general  partner
receivable due to recoveries received in excess of original estimates.  The 1997
reversal amounted to $283,000. 1998 revenue included a $239,000 gain on the sale
of the Florida  Denny's  Property.  Overall,  revenues have decreased due to the
sale  of  Properties,   leaving  fewer  revenue-generating   Properties  in  the
Partnership's portfolio.

Total revenues should approximate  $400,000 annually,  based on leases currently
in place.  Future  revenues may decrease  with tenant  defaults  and/or sales of
Properties.  They may also increase with additional  rents due from tenants,  if
those  tenants  experience  sales levels which require the payment of additional
rent to the Partnership.

Expenses

For the years ended December 31, 1998, 1997, and 1996, cash expenses amounted to
approximately 40%, 24%, and 48% of total revenues, respectively. Total expenses,
including  non-cash items,  amounted to 110%, 36%, and 62% of total revenues for
the  years  ended  December  31,  1998,  1997,  and  1996,  respectively.  Items
negatively  impacting expenses during the last three years are expenses incurred
in relation to the misappropriation of assets by the former general partners and
their affiliates,  write-offs of uncollectible rent, losses on equipment leases,
and Property  write-downs.  In addition,  during 1998 the  Partnership  incurred
legal fees,  appraisal  costs, and fees for  environmental  inspections and land
title surveys in connection with the proposed liquidation of the Partnership.

                                       8
<PAGE>
 
The losses,  write-offs,  Property  write-downs,  and  depreciation are non-cash
items  and do not  affect  current  operating  cash flow of the  Partnership  or
distributions to the Limited Partners.

Inflation:

Inflation has a minimal effect on operating earnings and related cash flows from
a portfolio  of triple net leases.  By their  nature,  such leases  actually fix
revenues and are not impacted by rising costs of maintenance, insurance, or real
estate taxes.  Although the  Partnership's  leases have percentage rent clauses,
percentage  rents  represented  only 3% of total  rental  income  for  1998.  If
inflation causes operating margins to deteriorate for lessees,  if expenses grow
faster than revenues,  then,  inflation may well negatively impact the portfolio
through tenant defaults.

It would be misleading to associate  inflation with asset  appreciation for real
estate, in general, and the Partnership's  portfolio,  specifically.  Due to the
"triple  net"  nature  of the  property  leases,  asset  values  generally  move
inversely with interest rates.

Year 2000:

The Partnership's  operations are not dependent on date sensitive software.  The
Partnership  is not aware of any Year 2000 problems  with its current  software.
Accounting  and  Partnership  records  software  are owned and operated by third
parties who provide services to the Partnership  under contract and the costs to
make these systems Year 2000 compliant  will be borne by the third parties.  The
Partnership  is  currently  in the process of  evaluating  Year 2000 issues with
these third party providers. The Partnership believes, however, that even if any
Year 2000  problems are not  corrected on schedule,  the cost and  disruption to
operations of the Partnership are expected to be minimal.

Tenants  are  responsible  for the  operation  of any  equipment  located at the
Partnership's  Properties.  While  the  Partnership  is not  fully  aware of the
compliance  attainment efforts of its tenants,  tenant preparedness for the Year
2000 should have minimal  impact on the  Partnership  and are not expected to be
material to the Partnership's operations,  financial condition or liquidity. The
Partnership does plan to evaluate the preparedness of its tenants.

Item 7A.  Quantitative and Qualitative Disclosure About Market Risk

None.

                                       9
<PAGE>
 
Item 8.  Financial Statements and Supplementary Data

                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                        (a Wisconsin limited partnership)

                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

                                                                        Page

Report of Independent Public Accountants ..........................    11

Balance Sheets, December 31, 1998 and 1997.........................    12 - 13

Statements of Income for the Years
Ended December 31, 1998, 1997, and 1996 ...........................    14

Statement of Partners' Capital for the
Years Ended December 31, 1998, 1997,
and 1996 ..........................................................    15

Statements of Cash Flows for the Years
Ended December 31, 1998, 1997, and 1996 ...........................    16 - 17

Notes to Financial Statements .....................................    18 - 25


Schedule III--Real Estate and Accumulated
Depreciation ......................................................    32



                                      10
<PAGE>
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS





To the Partners of
Divall Insured Properties 3 Limited Partnership:

We have audited the  accompanying  balance sheets of Divall Income  Properties 3
Limited Partnership(the  Partnership), as of December 31, 1998 and 1997, and the
related  statements of income,  partners' capital and cash flows for each of the
three years in the period ended December 31, 1998.  These  financial  statements
are the responsibility of the Partnership's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial  position of Divall  Income  Properties 3
Limited  Partnership,  as of December 31, 1998 and 1997,  and the results of its
operations  and its cash flows for each of the three  years in the period  ended
December 31, 1998, in conformity with generally accepted accounting principles.

Our audit was made for the purpose of forming an opinion on the basic  financial
statements  taken as a whole.  The  schedule  listed in the  index of  financial
statements  is  presented  for  purposes of complying  with the  Securities  and
Exchange  Commission's rules and is not part of the basic financial  statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic  financial  statements  and, in our opinion,  fairly  states in all
material  respects  the  financial  data  required  to be set forth  therein  in
relation to the basic financial statements taken as a whole.




Chicago, Illinois
February 18, 1999



                                      
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                                 BALANCE SHEETS

                           December 31, 1998 and 1997


                                     ASSETS

<TABLE>
<CAPTION>

                                                     December 31,   December 31,
                                                         1998           1997
INVESTMENT PROPERTIES:  (Note 3)
<S>                                                  <C>             <C>        
      Land                                           $ 1,553,680     $ 2,030,982
      Buildings and improvements                       2,249,959       3,309,464
      Accumulated depreciation                          (713,396)       (761,861)
                                                     -----------     -----------
           Net investment properties                   3,090,243       4,578,585
                                                     -----------     -----------
OTHER ASSETS:
      Cash and cash equivalents                          230,807         595,420
      Cash held in indemnification trust (Note 8)        306,386         290,662
      Rents and other receivables                         14,463          23,062
      Deferred rent receivable                            20,778          31,029
      Deferred fees                                       19,738          21,524
      Prepaid assets                                       3,393           3,649
                                                     -----------     -----------

           Total other assets                            595,565         965,346
                                                     -----------     -----------

      Total assets                                   $ 3,685,808     $ 5,543,931
                                                     ===========     ===========
</TABLE>





        The accompanying notes are an integral part of these statements.

                                      12
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                                 BALANCE SHEETS

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


                        LIABILITIES AND PARTNERS' CAPITAL

                                                                        December 31       December 31,
                                                                           1998             1997
<S>                                                                    <C>              <C>         
LIABILITIES:
      Accounts payable and accrued expenses                            $     18,816     $     25,331
      Due to current General Partner                                            229            1,395
      Security deposits                                                      16,635           36,819
      Unearned rental income                                                 27,254           42,254
                                                                       ------------     ------------
           Total liabilities                                                 62,934          105,799
                                                                       ------------     ------------
CONTINGENT LIABILITIES: (Note 7)

PARTNERS' CAPITAL: (Notes 1, 4 and 9)
      Current General Partner -
           Cumulative net income                                             14,756           15,445
           Cumulative cash distributions                                     (7,965)          (6,640)
                                                                       ------------     ------------

                                                                              6,791            8,805
                                                                       ------------     ------------
      Limited Partners (17,102.52 interests outstanding)
           Capital contributions, net of offering costs                  14,408,872       14,408,872
           Cumulative net loss                                             (294,314)        (226,070)
           Cumulative cash distributions                                (10,232,984)      (8,487,984)
           Reallocation of former general partners' deficit capital        (265,491)        (265,491)
                                                                       ------------     ------------
                                                                          3,616,083        5,429,327
                                                                       ------------     ------------
                Total partners' capital                                   3,622,874        5,438,132
                                                                       ------------     ------------
                Total liabilities and partners' capital                $  3,685,808     $  5,543,931
                                                                       ============     ============

</TABLE>




        The accompanying notes are an integral part of these statements.

                                      13
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                              STATEMENTS OF INCOME

              For the Years Ended December 31, 1998, 1997, and 1996

<TABLE>
<CAPTION>



                                                               1998           1997          1996
                                                            ----------     ----------    ----------
<S>                                                         <C>            <C>           <C>       
REVENUES:
     Rental income (Note 5)                                 $  420,630     $  597,697    $  674,703
     Interest income on direct financing leases                      0          1,708        85,204
     Interest income                                            39,573         31,435        51,243
     Other income                                                   94         17,714         1,217
     Gain on sale of assets                                    238,698          7,585             0
     Recovery of amounts previously written off (Note 2)             0        283,071       999,797
                                                            ----------     ----------    ----------
                                                               698,995        939,210     1,812,164
                                                            ----------     ----------    ----------
EXPENSES:

     Management fees (Note 6)                                   64,690         52,177        86,826
     Disposition fees (Note 6)                                  37,500         12,150             0
     Restoration fees (Note 6)                                       0         11,323        63,163
     Insurance                                                   4,328          4,925         5,112
     General and administrative                                 40,219         39,119        43,875
     Advisory Board fees and expenses                           17,850         14,752        16,332
     Appraisals                                                 13,776              0             0
     Environmental inspections                                   8,250              0             0
     Land title surveys                                         11,950              0             0
     Professional services                                      81,622         49,768        53,761
     Professional services related to Investigation              1,480         37,754       609,079
     Depreciation                                               84,103        110,951       117,318
     Amortization                                                1,786          1,786             0
     Loss on equipment leases                                        0              0       115,726
    Write-down of properties to net realizable value
     (Note 3)                                                  400,374              0         3,500
                                                            ----------     ----------    ----------

                                                               767,928        334,705     1,114,692
                                                            ----------     ----------    ----------
NET INCOME (LOSS)                                           $  (68,933)    $  604,505    $  697,472
                                                            ==========     ==========    ==========
NET INCOME (LOSS) - CURRENT GENERAL                         $     (689)    $    6,045    $    6,975
PARTNER
NET INCOME (LOSS)  - LIMITED PARTNERS                          (68,244)       598,460       690,497
                                                            ----------     ----------    ----------

                                                            $  (68,933)    $  604,505    $  697,472
                                                            ----------     ==========    ==========
NET INCOME (LOSS) PER LIMITED
  PARTNERSHIP INTEREST, based on 17,102.52
  interests outstanding                                     $    (3.99)    $    34.99    $    40.37
                                                            ==========     ==========    ==========

</TABLE>



        The accompanying notes are an integral part of these statements.

                                      14
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                         STATEMENTS OF PARTNERS' CAPITAL

              For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>



                                   Current General Partner                                  Limited Partners
                             ---------------------------------   -------------------------------------------------------------------

                                                                     Capital
                             Cumulative   Cumulative             Contributions,   Cumulative   Cumulative
                             Net Income     Cash                     Net of       Net Income      Cash
                               (Loss)   Distributions   Total    Offering Costs     (Loss)     Distributions  Reallocation   Total
<S>                           <C>        <C>       <C>            <C>           <C>           <C>            <C>         <C>       
BALANCE AT DECEMBER 31, 1995  $ 2,425    $(1,433)  $       992    $14,408,872   $(1,515,027)  $ (5,187,984)  $(265,491)  $7,440,370
Cash Distributions                      
   ($96.48 per limited                  
     partnership interest               
     outstanding)                         (2,789)       (2,789)                                 (1,650,000)              (1,650,000)

Net Income                      6,975                    6,975                      690,497                                 690,497
                              -------    -------   -----------    -----------   -----------   ------------   ---------   ----------
BALANCE AT DECEMBER 31, 1996  $ 9,400    $(4,222)  $     5,178    $14,408,872   $  (824,530)  $ (6,837,984)  $(265,491)  $6,480,867
                                        
  Cash Distributions                    
    ($96.48 per                         
     limited partnership                
     interest outstanding)                (2,418)       (2,418)                                 (1,650,000)              (1,650,000)

  Net Income                    6,045                    6,045                      598,460                                 598,460
                              -------    -------   -----------    -----------   -----------   ------------   ---------   ----------
BALANCE AT DECEMBER 31, 1997  $15,445    $(6,640)  $     8,805    $14,408,872   $  (226,070)  $ (8,487,984)  $(265,491)  $5,429,327
  Cash Distributions                    
    ($102.03 per                        
     limited partnership                
     interest outstanding)                (1,325)       (1,325)                                 (1,745,000)              (1,745,000)

  Net Loss                       (689)                    (689)                     (68,244)                                (68,244)

                              -------    -------   -----------    -----------   -----------   ------------   ---------   ----------
                                        
BALANCE AT DECEMBER 31, 1998  $14,756    $(7,965)  $     6,791    $14,408,872   $  (294,314)  $(10,232,984)  $(265,491)  $3,616,083
                              =======    =======   ===========    ===========   ===========   ============   =========   ==========

</TABLE>                                
                                        
        The accompanying notes are an integral part of these statements.
                                        
                                      15
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                            STATEMENTS OF CASH FLOWS

              For the Years Ended December 31, 1998, 1997, and 1996

<TABLE>
<CAPTION>


                                                                                   1998            1997            1996
                                                                                -----------     -----------     -----------

<S>                                                                             <C>             <C>             <C>        
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
     Net income (loss)                                                          $   (68,933)    $   604,505     $   697,472
     Adjustments to reconcile net income (loss) to net cash
             from (used in) operating activities -
          Depreciation and amortization                                              85,889         112,737         117,318
          Write-down of properties to net realizable value                          400,374               0           3,500
          Net gain on disposition                                                  (238,698)         (7,585)              0
          Recovery of amounts previously written off                                      0        (283,071)       (999,797)
          Loss on equipment leases                                                        0               0         115,726
          Interest applied to Indemnification Trust Account                         (15,724)        (14,414)        (13,523)
          (Increase)/Decrease in rents, other receivables and prepaid assets          8,855           4,667            (729)
          Decrease in deferred rent receivable                                       10,251          10,079           1,796
          Deposits (received) applied for real estate taxes                               0          81,447         (38,648)
          (Decrease) in accounts payable and accrued expenses                        (6,515)         (4,949)       (221,668)
          Increase/(Decrease) in due to General Partner                              (1,166)        (47,932)         26,017
          (Decrease) in security deposits                                           (20,184)        (10,160)        (10,614)
          Increase/(Decrease) in real estate taxes payable                                0         (81,217)         78,033
          Increase/(Decrease) in unearned rental income                             (15,000)         15,665          26,589
                                                                                -----------     -----------     -----------

               Net cash provided from (used in) operating activities                139,149         379,772        (218,528)
                                                                                -----------     -----------     -----------

CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
     Principal payments received on direct financing leases                               0          25,017         753,954
     Deposit to Indemnification Trust Account                                             0               0         (20,000)
     Recoveries from former G.P. affiliates                                               0         283,071       2,066,936
     Proceeds from sale of land and buildings                                     1,242,563         404,850          36,176
     Principal receipts from note                                                         0               0          79,001
                                                                                -----------     -----------     -----------

               Net cash provided from investing activities                        1,242,563         712,938       2,916,067
                                                                                -----------     -----------     -----------


CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
     Payments of amounts due to affiliated partnerships                                   0               0        (201,912)
     Cash distributions to General Partner                                           (1,325)         (2,418)         (2,789)
     Cash distributions to Limited Partners                                      (1,745,000)     (1,650,000)     (1,650,000)
                                                                                -----------     -----------     -----------

               Net cash (used in) financing activities                           (1,746,325)     (1,652,418)     (1,854,701)
                                                                                -----------     -----------     -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                               (364,613)       (559,708)        842,838
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                      595,420       1,155,128         312,290
                                                                                -----------     -----------     -----------

CASH AND CASH EQUIVALENTS AT END OF YEAR                                        $   230,807     $   595,420     $ 1,155,128
                                                                                ===========     ===========     ===========
</TABLE>



        The accompanying notes are an integral part of these statements.


                                      16
<PAGE>
 
            Supplemental Information to the Statements of Cash Flows

The following  significant non-cash transactions occurred during the three years
affecting the Partnership's financial statements:

         1.       During 1996, the  Partnership  was deeded land with a value of
                  $36,176 in exchange for a note receivable from a tenant.

         2.       During 1996,  security  deposits totaling $45,588 were applied
                  as equipment lease payments for a tenant.

         3.       During 1996,  the  Partnership  incurred  leasing  commissions
                  totaling $23,310 which were unpaid at year-end. The amount was
                  paid in full during 1997.
































        The accompanying notes are an integral part of these statements.

                                       17
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP

                          NOTES TO FINANCIAL STATEMENTS

                        DECEMBER 31, 1998, 1997, AND 1996

1.  ORGANIZATION AND BASIS OF ACCOUNTING:

DiVall Income Properties 3 Limited Partnership (the "Partnership") was formed on
December 12, 1989,  pursuant to the Uniform Limited Partnership Act of the State
of Wisconsin.  The initial capital which was contributed during 1989,  consisted
of $300,  representing  aggregate  capital  contributions  of $200 by the former
general partners and $100 by the Initial Limited Partner.

The Partnership  initially offered two classes of Limited Partnership  interests
for  sale:  Distribution  interests   ("D-interests")  and  Retention  interests
("R-interests").  Each class was offered at a price (before volume discounts) of
$1,000 per  interest.  The  Partnership  offered  the two  classes of  interests
simultaneously up to an aggregate of 25,000 interests.

The minimum  offering  requirements  for the  D-interests  were met and escrowed
subscription  funds were released to the  Partnership  as of July 13, 1990.  The
offering closed on April 23, 1992, at which point 17,102.52 D-interests had been
issued, resulting in aggregate proceeds, net of discounts and offering costs, of
$14,408,872.

The minimum  offering  requirements  for R-interests  were not met. During 1991,
680.9   R-interests   were  converted  to  D-interests  and  were  reflected  as
Partnership issuances in 1991.

The Partnership is currently engaged in the business of owning and operating its
investment   portfolio  (the   "Properties")  of  commercial  real  estate.  The
Properties are leased on a triple net basis to, and operated by,  franchisors or
franchisees  of  national,  regional and local  retail  chains  under  long-term
leases.  The  lessees  consist of  fast-food,  family  style,  and  casual/theme
restaurants. At December 31, 1998, the Partnership owned five (5) properties and
specialty leasehold improvements for use in all five (5) of the Properties.

Rental  revenue from  investment  properties is recognized on the  straight-line
basis over the life of the  respective  lease.  Revenue  from  direct  financing
leases  is  recognized  at level  rates of  return  over the term of the  lease.
Percentage  rents are accrued  throughout the year based on the tenant's  actual
reported  year-to-date  sales along with  Management's  estimate of the tenant's
sales for any remaining unreported periods during the year.

The  Partnership  operates in only one segment and therefore no further  segment
reporting is made.

Depreciation  of the properties is provided on a  straight-line  basis over 31.5
years, which is the estimated useful lives of the buildings and improvements.

Deferred charges represent  leasing  commissions paid when properties are leased
to tenants other than the original tenant.  Leasing  commissions are capitalized
and amortized over the life of the lease.

                                      18
<PAGE>
 
Real  estate  taxes  on  the   Partnership's   investment   properties  are  the
responsibility of the tenant.  However, when a tenant fails to make the required
tax  payments  or when a property  becomes  vacant,  the  Partnership  makes the
appropriate  payment to avoid possible  foreclosure  of the property.  Taxes are
accrued in the period for which the liability is incurred.

Cash and cash equivalents include cash on deposit in financial  institutions and
highly liquid temporary investments with initial maturities of 90 days or less.

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

Certain  reclassifications have been made to the prior year financial statements
to make them consistent with the current year presentation.

During 1996, the Partnership adopted Statement of Financial Accounting Standards
No.121 ("SFAS 121"),  Accounting for the Impairment of Long-Lived Assets and for
Long-Lived  Assets to be Disposed of, which requires that all long-lived  assets
be reviewed for impairment in value whenever changes in  circumstances  indicate
that the  carrying  amount of an asset may not be  recoverable.  The adoption of
SFAS 121 had no impact on the Partnership's financial statements.

The Partnership will be dissolved on December 1, 2015, or earlier upon the prior
occurrence of any of the following events:  (a) the disposition of all interests
in real estate and other Partnership  assets;  (b) the decision by Majority Vote
of the Limited Partners to dissolve the Partnership or to compel the sale of all
or substantially  all of the  Partnership's  assets;  (c) the failure to elect a
successor  General Partner within six months after removal of the last remaining
General  Partner;  or (d)  the  date  of the  death  or the  effective  date  of
dissolution,  removal,  withdrawal,  bankruptcy,  or  incompetency  of the  last
remaining  General  Partner,  unless the Partnership is continued by vote of all
Limited  Partners and a replacement  General Partner is previously  elected by a
majority of the Limited  Partners.  The General Partner  received the consent of
the Limited  Partners to  liquidate  the  Partnership's  assets and dissolve the
Partnership,  during the Second Quarter of 1998. Management is currently seeking
a buyer for the  Partnership's  Properties within the parameters of the consent.
However,  Management  expects to continue normal  operations for the Partnership
for the foreseeable future.

No provision  for Federal  income taxes has been made, as any liability for such
taxes would be that of the individual  partners rather than the Partnership.  At
December  31,  1998,  the tax basis of the  Partnership's  assets  exceeded  the
amounts  reported in the  accompanying  financial  statements  by  approximately
$3,200,000.


                                      19
<PAGE>
 
The following  represents a reconciliation of net income (loss) as stated on the
Partnership's statements of income to net income for tax reporting purposes:

<TABLE>
<CAPTION>


                                                 1998          1997          1996
                                              ---------     ---------     ---------
<S>                                           <C>           <C>           <C>      
Net income (loss) per statements of income    $ (68,933)    $ 604,505     $ 697,472
Book to tax depreciation difference                 368         8,014         8,491
Straight line rent adjustment                   (10,251)      (10,079)       (1,796)
Prepaid rent                                    (15,000)            0             0
Property write-downs                            400,374             0             0
Allowance for receivables                             0             0       (45,730)
Loss on equipment leases                              0             0       (53,288)
Other, net                                       (2,547)        5,231      (168,552)
                                              ---------     ---------     ---------
Net income for tax reporting purposes         $ 304,011     $ 607,671     $ 436,597
                                              =========     =========     =========
</TABLE>

2.       REGULATORY INVESTIGATION:

A preliminary  investigation  during 1992 by the Office of the  Commissioner  of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the  "Investigation")  revealed  that  during at least the  three  years  ended
December 31,  1992,  the former  general  partners of the  Partnership,  Gary J.
DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred  substantial
cash  assets  of  the  Partnership  and  two  affiliated   publicly   registered
partnerships,  DiVall Insured Income Fund Limited  Partnership  ("DiVall 1") and
DiVall   Insured   Income   Properties  2  Limited   Partnership   ("DiVall  2")
(collectively the "Partnerships") to various other entities previously sponsored
by or otherwise affiliated with DiVall and Magnuson.  The unauthorized transfers
were in violation of the  respective  Partnership  Agreements  and resulted,  in
part,  from  material   weaknesses  in  the  internal   control  system  of  the
Partnerships.

Subsequent  to  discovery,  and in  response  to  the  regulatory  inquiries,  a
third-party  Permanent  Manager,  The Provo Group, Inc.  ("TPG"),  was appointed
(effective  February 8, 1993) to assume  responsibility for daily operations and
assets  of the  Partnerships  as  well  as to  develop  and  execute  a plan  of
restoration for the Partnerships.  Effective May 26, 1993, the Limited Partners,
by written  consent of a majority of interests,  elected the Permanent  Manager,
TPG, as General Partner. TPG terminated the former general partners by accepting
their tendered resignations.

In 1993,  the current  General  Partner  estimated an  aggregate  recovery of $3
million for the Partnerships. At that time, an allowance was established against
amounts due from former  general  partners and their  affiliates  reflecting the
estimated $3 million  receivable.  This net receivable  was allocated  among the
Partnerships   based  on  each   Partnership's  pro  rata  share  of  the  total
misappropriation.  Restoration expenses and recoveries have been allocated based
on the same  percentages.  Through  December 31, 1998,  $5,766,000 of recoveries
have been  received  which  exceeded the original  estimate of $3 million.  As a
result,  during 1996 and 1997,  the  Partnership  has  recognized  $1,283,000 as
income,  which represents its share of the excess recovery.  The current General
Partner continues to pursue recoveries of the misappropriated funds, however, no
further significant recoveries are anticipated.

                                      20
<PAGE>
 
3.  INVESTMENT PROPERTIES:

As of December 31, 1998, the  Partnership  owned five (5) fast-food  restaurants
comprised of: two (2) Hardee's restaurants,  one (1) Applebee's restaurant,  and
two (2) Denny's  restaurants.  The five (5)  properties are located in three (3)
states.

During 1997, the Partnership sold its Hardee's property in Wahoo,  Nebraska, for
approximately  $405,000,  resulting  in a  gain,  before  disposition  fees,  of
approximately $8,000.

During  January  1998,  the  Partnership  sold its Denny's  property in Sanford,
Florida,  to the tenant for $1,250,000,  resulting in a gain, before disposition
fees, of approximately $240,000.

The total cost of the investment properties includes the original purchase price
plus  acquisition fees and other  capitalized  costs paid to an affiliate of the
former general partners.

In connection with the proposed liquidation of the Partnership,  appraisals were
received on all of the Partnership's  Properties.  The two Hardee's were written
down to their estimated net realizable values based on the appraisals  received.
The write-downs totaled approximately $400,000.

According to the  Partnership  Agreement,  the former  general  partners were to
commit 82% of the original  offering  proceeds to the  acquisition of investment
properties.  Upon the close of the offering,  approximately  57% of the original
offering proceeds was invested in the Partnership's properties.

The current General Partner receives a fee for managing the Partnership equal to
4% of gross receipts,  with a maximum  reimbursement for office rent and related
office overhead of $25,000 between the three affiliated Partnerships.  Effective
March 1, 1998,  the minimum  management  fee and the maximum  reimbursement  for
office rent and overhead  increased by 1.6%  representing  the allowable  annual
Consumer Price Index adjustment per the Permanent Manager Agreement ("PMA"). For
purposes of  computing  the 4% overall  fee,  gross  receipts  includes  amounts
recovered  in  connection  with the  misappropriation  of assets  by the  former
general  partners  and  their  affiliates.   TPG  has  received  fees  from  the
Partnership  totaling $87,897 to date on the amounts  recovered,  which has been
offset against the 4% minimum fee.

Several of the Partnership's  property leases contain purchase option provisions
with stated  purchase  prices in excess of the original cost of the  properties.
The current General Partner is unaware of any  unfavorable  purchase  options in
relation to original cost.


4.       PARTNERSHIP AGREEMENT:

The  Partnership  Agreement,  prior  to an  amendment  effective  May 26,  1993,
provided that, for financial  reporting and income tax purposes,  net profits or
losses from operations were allocated 90% to the Limited Partners and 10% to the
former general partners.  The Partnership  Agreement also provided that Net Cash
Receipts,  as defined,  would be distributed 90% to the Limited Partners and 10%
to the former general

                                      21
<PAGE>
 
partners,  except that distributions to the former general partners in excess of
1% in any calendar year would be  subordinated to  distributions  to the Limited
Partners in an amount equal to their Original Property Distribution  Preference,
as defined.

Net  proceeds,  as defined,  were to be  distributed  as follows:  (a) 1% to the
General  Partners and 99% to the Limited  Partners,  until  distributions to the
Limited Partners equal their Original Capital,  as defined,  plus their Original
Property  Liquidation  Preference,  as defined, and (b) the remainder 90% to the
Limited Partners and 10% to the General Partners.  Such distributions were to be
made as soon as practicable  following the sale,  financing or refinancing of an
original property.

On May 26, 1993,  pursuant to the results of a solicitation of written  consents
from the Limited Partners,  the Partnership Agreement was amended to replace the
former general partners and amend various sections of the agreement.  The former
general partners were replaced as General Partner,  by The Provo Group, Inc., an
Illinois  Corporation.  Under the terms of the amendment,  net profits or losses
from operations are allocated 99% to the Limited  Partners and 1% to the current
General  Partner.  The amendment also provided for  distributions  from Net Cash
Receipts to be made 99% to the Limited  Partners  and 1% to its current  General
Partner.  Pursuant to the amendments to the Partnership Agreement effective June
30, 1994,  distributions  of Net Cash  Receipts  will not be made to the General
Partner unless and until each Limited  Partner has received a distribution  from
Net Cash Receipts in an amount equal to 10% per annum,  cumulative simple return
on his or her Adjusted Original Capital, as defined, from the Return Calculation
Date, as defined,  except to the extent needed by the General Partner to pay its
federal and state income taxes on the income  allocated  to it  attributable  to
such year.  Distributions paid to the General Partner are based on the estimated
tax liability as a result of allocated  income.  Subsequent to the filing of the
General Partner's income tax returns, a true-up of actual distributions is made.
Net proceeds,  as defined,  was also amended to be distributed 1% to the current
General Partner and 99% to the Limited Partners.

Additionally,  as per the amendment of the  Partnership  Agreement dated May 26,
1993, the total  compensation paid to all persons for the sale of the investment
properties  shall be limited to a  competitive  real estate  commission,  not to
exceed  6% of the  contract  price  for the sale of the  property.  The  General
Partner may receive up to one-half of the  competitive  real estate  commission,
not to exceed 3%,  provided  that the  General  Partner  provides a  substantial
amount of services in the sales effort. It is further provided that a portion of
the amount of such fees payable to the General  Partner is  subordinated  to its
success at recovering the funds  misappropriated by the former general partners.
(See Note 7.)

Effective June 1, 1993, the Partnership  Agreement was amended to (i) change the
definition of  "Distribution  Quarter" to be consistent with calendar  quarters,
and (ii) change the distribution provisions to subordinate the General Partner's
share of  distributions  from Net Cash Receipts and Net Proceeds,  except to the
extent  necessary  for the General  Partner to pay its federal and state  income
taxes on  Partnership  income  allocated to the General  Partner.  Because these
amendments do not adversely affect the rights of the Limited Partners,  pursuant
to section 10.2 of the  Partnership  Agreement,  the amendments were made by the
General Partner without a vote of the Limited Partners.

5.  LEASES:

Lease terms for the investment properties are 20 years from their inception. The
leases provide for minimum rents and additional  rents based upon percentages of
gross sales in excess of specified

                                      22
<PAGE>
 
breakpoints.  The lessee is responsible for occupancy costs such as maintenance,
insurance, real estate taxes, and utilities.

Accordingly, these amounts are not reflected in the statements of income, except
in  circumstances  where,  in  management's  opinion,  the  Partnership  will be
required to pay such costs to preserve  assets  (i.e.,  payment of past-due real
estate taxes). Management has determined that the leases are properly classified
as operating  leases;  therefore,  rental income is reported when earned and the
cost of the property,  excluding the cost of the land, is  depreciated  over its
estimated useful life.

Aggregate  minimum  lease  payments  to be  received  under the  leases  for the
Partnership's properties are as follows:

<TABLE>
<CAPTION>
Year ending
December 31,
<S>        <C>                                            <C>     
           1999                                           $409,380
           2000                                            409,380
           2001                                            409,380
           2002                                            409,380
           2003                                            409,380
Thereafter                                               2,731,958
                                                        ----------
                                                        $4,778,858
                                                        ==========
</TABLE>


Percentage  rentals  included  in  rental  income in 1998,  1997,  and 1996 were
$11,692, $20,658, and $13,399, respectively.

Two (2) of the Partnership's properties are leased to a Denny's franchise.  Base
rent from these properties  amounted to approximately  27% of total base rent in
1998.

Two (2) of the Partnership's properties are leased to a Hardee's franchise. Base
rent from these properties is approximately 43% of total base rents.

The original  offering document required the Partnership to lease its properties
to a single tenant as long as the properties so leased do not constitute; in the
aggregate,  more than 20% of the aggregate gross proceeds of the offering. As of
December 31, 1998, the  Partnership has leased two of its properties to Hardee's
Food Systems, Inc., which constituted 21% of the aggregate gross proceeds.






                                      23
<PAGE>
 
6.       TRANSACTIONS WITH CURRENT GENERAL PARTNER:

Amounts incurred to the current General Partner for the years ended December 31,
1998, 1997, and 1996, are as follows:
<TABLE>
<CAPTION>


Current General Partner                                 Incurred               Incurred          Incurred for the
                                                    for the year ended    for the year ended        year ended
                                                    December 31, 1998     December 31, 1997      December 31, 1996
                                                    -----------------     -----------------      -----------------
<S>                                                       <C>                   <C>                   <C>     
Management fees                                           $64,690               $52,177               $ 86,826
Disposition fees                                           37,500                12,150                      0
Restoration fees                                                0                11,323                 63,163
Leasing commissions                                             0                     0                 23,310
Cash distribution                                           1,325                 2,418                  2,789
Overhead allowance                                          5,219                 5,150                  5,127
Reimbursement for out-of-pocket expenses                   10,229                11,493                  9,118
                                                           ------                ------               --------
                                                         $118,963               $94,711              $ 190,333
                                                         ========               =======                =======
</TABLE>



7.  CONTINGENT LIABILITIES:

According to the Partnership Agreement,  as amended, the current General Partner
may receive a disposition fee not to exceed 3% of the contract price of the sale
of  investment  properties.  Fifty percent  (50%) of all such  disposition  fees
earned by the  current  General  Partner is to be escrowed  until the  aggregate
amount of recovery of the funds  misappropriated  from the  Partnerships  by the
former general partners is greater than $4,500,000.  Upon reaching such recovery
level,  full disposition fees will thereafter be payable and fifty percent (50%)
of the previously  escrowed amounts will be paid to the current General Partner.
At such time as the recovery exceeds $6,000,000 in the aggregate,  the remaining
escrowed  disposition fees shall be paid to the current General Partner. If such
levels of recovery are not achieved, the current General Partner will contribute
the amounts escrowed towards the recovery. In lieu of an escrow, 50% of all such
disposition  fees have been paid  directly  to a  restoration  account  and then
distributed  among  the three  Partnerships.  Fifty  percent  (50%) of the total
amount paid to the recovery was refunded to the current  General  Partner during
1996,  after  exceeding the  $4,500,000  recovery  level.  The remaining  amount
allocated to the  Partnerships may be owed to the current General Partner if the
$6,000,000  recovery level is met. As of December 31, 1998, the  Partnership may
owe the current General Partner $18,862, which has been reflected as a recovery,
if the $6,000,000 recovery level is achieved. Management believes it is unlikely
that this recovery level will be achieved.

8.       PMA INDEMNIFICATION TRUST:

The Permanent Manager Agreement ("PMA") provides that the Permanent Manager will
be  indemnified  from any claims or  expenses  arising out of or relating to the
Permanent Manager serving in such capacity or as substitute general partner,  so
long as such claims do not arise from  fraudulent or criminal  misconduct by the
Permanent   Manager.   The  PMA  provides   that  the   Partnership   fund  this
indemnification  obligation  by  establishing  a reserve  of up to  $250,000  of
Partnership assets which would not be subject to the claims of the Partnership's
creditors. An Indemnification Trust ("Trust") serving such purposes has been

                                      24
<PAGE>
 
established at United  Missouri Bank,  N.A. The Trust has been fully funded with
Partnership  assets as of December 31, 1998. Funds are invested in U.S. Treasury
securities.  In addition,  interest  totaling  $56,386 has been  credited to the
Trust as of December 31, 1998. The rights of the Permanent  Manager to the Trust
shall be terminated upon the earliest to occur of the following events:  (i) the
written  release by the Permanent  Manager of any and all interest in the Trust;
(ii)  the  expiration  of the  longest  statute  of  limitations  relating  to a
potential claim which might be brought  against the Permanent  Manager and which
is subject to indemnification;  or (iii) a determination by a court of competent
jurisdiction  that the  Permanent  Manager shall have no liability to any person
with  respect to a claim which is subject to  indemnification  under the PMA. At
such time as the indemnity  provisions expire or the full indemnity is paid, any
funds  remaining  in the Trust  will  revert  back to the  general  funds of the
Partnership.

9.       FORMER GENERAL PARTNERS' CAPITAL ACCOUNTS:

The capital account  balance of the former general  partners as of May 26, 1993,
the date of their  removal  as general  partners  pursuant  to the  results of a
solicitation  of written  consents from the Limited  Partners,  was a deficit of
$265,491.  At December 31, 1993, the former general  partners'  deficit  capital
account  balance  in the  amount of  $265,491  was  reallocated  to the  Limited
Partners.

10.      SUBSEQUENT EVENTS:

In February 1999, the Partnership  made a distribution  to the Limited  Partners
from  operations for the Fourth  Quarter 1998 of $60,000  amounting to $3.51 per
Interest.


                                      25
<PAGE>
 
Item  9.  Changes  in and  Disagreements  With  Accountants  on  Accounting  and
          Financial Disclosure

None

                                    PART III

Item 10.  Directors and Executive Officers of the Registrant

TPG is an  Illinois  corporation  with its  principal  office  at 101 West  11th
Street, Suite 1110, Kansas City, Missouri 64105. TPG was elected General Partner
by vote of the Limited Partners  effective May 26, 1993. Prior to such date, TPG
had been managing the Partnership since February 8, 1993, under the terms of the
Permanent Manager Agreement ("PMA"), which remains in effect. TPG also serves as
the  corporate  general  partner  for  DiVall 2. See  Items 1 and 13 hereof  for
additional  information  about the PMA and the  election  of TPG as the  General
Partner.

The  executive  officers  and  director of the  General  Partner who control the
affairs of the Partnership are as follows:

         Bruce A. Provo, Age 48 - President, Founder and Director. Mr. Provo has
         been  involved  in the  management  of  real  estate  and  other  asset
         portfolios  since 1979. Since he founded the company in 1985, Mr. Provo
         has been  President  of TPG.  From 1982 to 1986,  Mr.  Provo  served as
         President  and  Chief  Operating  Officer  of  the  North  Kansas  City
         Development Company ("NKCDC"),  North Kansas City, Missouri.  NKCDC was
         founded in 1903 and the assets of the  company  were sold in  December,
         1985  for   $102,500,000.   NKCDC  owned   commercial   and  industrial
         properties,  including an office park and a retail district, as well as
         apartment  complexes,   motels,   recreational  facilities,  fast  food
         restaurants,  and other properties.  NKCDC's holdings consisted of over
         100  separate  properties  and  constituted  approximately  20%  of the
         privately  held real  property in North Kansas  City,  Missouri (a four
         square mile  municipality).  Following the sale of the  company's  real
         estate,  Mr. Provo served as the President and Chief Executive  Officer
         and Liquidating Trustee of NKCDC from 1986 to 1991.

         Mr. Provo graduated from Miami University,  Oxford, Ohio in 1972 with a
         B.S. in Accounting. He became a Certified Public Accountant in 1974 and
         was a manager in the banking and financial  services division of Arthur
         Andersen LLP prior to joining Rubloff Development  Corporation in 1979.
         From 1979 through  1985,  Mr. Provo served as Vice  President - Finance
         and then as President of Rubloff Development Corporation. Mr. Provo has
         previously  served on the Board of  Directors  of the  National  Realty
         Committee,  a legislative  "watchdog"  organization  for the commercial
         real estate industry headquartered in Washington, DC.

         Kristin  J.   Atkinson,   Age  36  -  Vice   President  -  Finance  and
         Administration.  Ms.  Atkinson joined TPG in September 1994, to provide
         management  expertise in the areas of financial controls and management
         accounting services for four limited partnerships

                                      26
<PAGE>
 
         managed by TPG.  Prior to joining  TPG,  Ms.  Atkinson  was  Manager of
         Financial  Reporting for Farm & Home Savings  Association (a $4 billion
         savings and loan  association) for nine years where she was responsible
         for supervision of the  preparation of internal and external  financial
         documentation, including regulatory filings for the savings association
         and its parent company.  Ms. Atkinson  graduated Magna Cum Laude with a
         B.S. in  Accounting  from  Missouri  Southern  State College in Joplin,
         Missouri  and worked as an  accountant  for James P. Arthur and Company
         for one year before joining Farm & Home Savings Association.

The Advisory  Board,  although  its members are not  "Directors"  or  "Executive
Officers" of the Partnership,  provides advisory  oversight to management of the
Partnership and consists of:

         Steve Carson - Self-Employed  Investment Advisor.  Mr. Carson's primary
         client concentration  includes labor union, pension, and annuity funds.
         Mr. Carson worked for First Albany  Corporation  for 11 years. He began
         his  career as a retail  broker at E.F  Hutton & Company  and served as
         Vice President,  Shearson  American Express from 1980- 1986. Mr. Carson
         attended Northrup University in Los Angeles,  California. He has served
         as Board Member and President on various Civic Boards in Syracuse,  New
         York. Mr. Carson represents the broker-dealer community.

         Richard W. Otte - Editorial Writer. Mr. Otte is in his sixth year as an
         Editorial Board Member and editorial writer for The Volusion, a DeLand,
         Florida,  subsidiary of the News-Journal  Corporation in Daytona Beach,
         Florida.  Mr.  Otte  retired in 1988  after 34 years with the  Dispatch
         Printing  Co.,  serving his last eight years as Managing  Editor of the
         Columbus  Dispatch  and as a  member  of its  Operating  Committee.  He
         previously  was the executive  sports editor of the newspaper in Ohio's
         capital  city.  Mr.  Otte's 49 years in  professional  journalism  also
         include news reporting, editing and sports assignments with the Daytona
         Journal Herald and Springfield News-Sun.  Mr. Otte is a Limited Partner
         representing DiVall 2.

         Albert  Gerritz - Retired,  Perinton  Volunteer  Ambulance  Corps.  Mr.
         Gerritz  has  held  various  offices  in  Finance  and  Administration,
         including  President.  Mr. Gerritz  retired in 1986 after 36 years with
         Eastman  Kodak Co. where he was  Supervisor  of  Engineering  Services,
         Research Labs. Mr. Gerritz was instrumental in identifying the need and
         pursuing the development of a unique research complex for Kodak,  which
         became  the  case  study  for his  consulting  activities  on  research
         facilities  nationwide.  Mr. Gerritz also worked for forty years in the
         Bushnell's  Basin Fire  Department and served five years as Chief.  Mr.
         Gerritz  has a life  membership  in  National  Society of  Professional
         Engineers. Mr. Gerritz is a Limited Partner representing DiVall 3.

Item 11.  Executive Compensation

The  Partnership  has not paid any  "executive  compensation"  to the  corporate
General  Partner or to the  directors and officers of the General  Partner.  The
General Partner's participation in the income of the Partnership is set forth in
the Partnership Agreement, which is filed as Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5
hereto.  The  current  General  Partner  received  management  fees and  expense
reimbursements during the year.

                                      27
<PAGE>
 
See Item 13 below, and Note 6 to the financial  statements in Item 8 hereof, for
further  discussion of payments by the  Partnership  to the General  Partner and
former general partners.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

(a) As of December 31, 1998, the following  entity is known to beneficially  own
5% or more of the outstanding Interests as follows:

<TABLE>
<CAPTION>


                                                              Interests         Percentage of
Title of                   Name and Address of               Beneficially       Interests of
 Class                      Beneficial Owner                    Owned            Outstanding
 -----                      ----------------                    -----            -----------
<S>                      <C>                                    <C>                 <C>  
Limited Partnership      The Engineers Joint Pension Fund       1,500               8.77%
Interests                4325 S. Salina Street
                         Syracuse, NY 13205
</TABLE>

(b) As of  December  31,  1998,  neither  the  General  Partner  nor  any of its
affiliates owned any Interests in the Partnership.

Item 13.  Certain Relationships and Related Transactions

The compensation to be paid to TPG is governed by the Partnership Agreement,  as
amended by vote of the Limited  Partners to reflect the terms of the PMA.  TPG's
compensation  includes  a  base  fee  equal  to 4% of  the  Partnership's  gross
collected receipts,  subject to a minimum of $57,000 per year. For this purpose,
"gross  collected  receipts" means all cash revenues arising from operations and
reserves of the Partnerships,  including any proceeds  recovered with respect to
the  obligations  of the  former  general  partners.  The  portion  of such  fee
resulting  from  recoveries  from  former  general  partners  is  designated  as
restoration  fees.  TPG is also  entitled to  reimbursement  for office rent and
utilities not to exceed  $4,750 per year.  TPG is entitled to  reimbursement  of
reasonable  direct  costs  and  expenses,  such as  travel,  lodging,  overnight
delivery  and  postage,  but has no right to be  reimbursed  for  administrative
expenses  such as  payroll,  payroll  taxes,  insurance,  retirement  and  other
benefits,  base phone and fax charges,  office  furniture and equipment,  copier
rent, and the like.  Between the  Partnerships,  TPG is entitled to an aggregate
minimum base  management fee of $300,000 per year and  reimbursement  for office
rent in the maximum  amount of $25,000 per year. The  Partnership  shall only be
responsible  for its  allocable  share of such  minimum and  maximum  amounts as
indicated   above   ($57,000   minimum   base  fee  and  $4,750   maximum   rent
reimbursement).  TPG is  entitled  to an annual  increase  in the  minimum  base
management fee and maximum  office  overhead  reimbursement  in an amount not to
exceed the  percentage  increase in the  Consumer  Price  Index  ("CPI") for the
immediately  preceding  calendar  year.  Effective  March 1, 1998,  the  minimum
management  fee and the  maximum  reimbursement  for  office  rent and  overhead
increased  by  1.6%   representing   the   allowable   annual  CPI   adjustment.
Additionally,  TPG is allowed up to  one-half  of the  Competitive  Real  Estate
Commission,  not to exceed 3% upon the  disposition of assets.  The payment of a
portion of such fees is  subordinated  to TPG's success at recovering  the funds
misappropriated by the former general partners.

The PMA has an  expiration  date of December  31,  2002,  but may be  terminated
earlier  (a) by a vote at any time by a  majority  in  interest  of the  Limited
Partners,  (b) upon the dissolution and winding up of the Partnership,  (c) upon
the entry of an order of a court finding that the Permanent  Manager has engaged
in

                                      28
<PAGE>
 
fraud or other like misconduct or has shown itself to be incompetent in carrying
out its  duties  under the  Partnership  Agreement,  or (d) upon sixty (60) days
written  notice  from the  Permanent  Manager  to the  Limited  Partners  of the
Partnership.  Upon termination of the PMA, other than by the voluntary action of
TPG, TPG shall be paid a  termination  fee of one month's Base Fee  allocable to
the  Partnership,  subject  to a minimum  of  $4,750.  In the event  that TPG is
terminated by action of a substitute general partner, TPG shall also receive, as
part of this termination  fee, 4% of any proceeds  recovered with respect to the
obligations  of  the  former  general  partners,   whenever  such  proceeds  are
collected.

Under the PMA, TPG shall be indemnified by the Partnership, DiVall and Magnuson,
and their controlled  affiliates,  and shall be held harmless from all claims of
any  party to the  Partnership  Agreement  and from any third  party  including,
without  limitation,  the Limited Partners of the  Partnership,  for any and all
liabilities, damages, costs, and expenses, including reasonable attorneys' fees,
arising  from or related to claims  relating  to or arising  from the PMA or its
status as  Permanent  Manager.  The  indemnification  does not  extend to claims
arising  from  fraud  or  criminal  misconduct  of TPG as  established  by court
findings.  To the  extent  possible,  the  Partnership  is to  provide  TPG with
appropriate  errors and  omissions,  officers  liability  or  similar  insurance
coverage, at no cost to TPG. In addition,  TPG is granted the right to establish
the Trust in an amount not to exceed $250,000, solely for the purpose of funding
such  indemnification  obligations.  Once a determination  has been made that no
such  claims  can or will be made  against  TPG,  the  balance of the Trust will
become  unrestricted  cash of the  Partnership.  As of December  31,  1998,  the
Partnership had fully funded the Trust.

The following  fees and  reimbursements  from the  Partnership  were incurred to
management in 1998:

<TABLE>
<CAPTION>


    The Provo Group, Inc.

<S>                                                        <C>    
         Management Fees                                   $64,690
         Disposition Fees                                   37,500
         Office Overhead Allowance                           5,219
         Direct Cost Reimbursements                         10,229
                                                           -------

             1998 Total                                   $117,638
                                                          ========
</TABLE>










                                      29
<PAGE>
 
                                    PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)     1.   Financial Statements
   
             The following financial statements of DiVall Income Properties
             3 Limited Partnership are included in Part II, Item 8:
   
             Report of Independent Public Accountants
   
             Balance Sheets, December 31, 1998 and 1997
   
             Statements  of Income for the Years Ended  December  31, 1998,
             1997 and 1996
   
             Statements of Partners'  Capital for the Years Ended  December
             31, 1998, 1997 and 1996
   
             Statements  of Cash  Flows for the Years  Ended  December  31,
             1998, 1997 and 1996
   
             Notes to Financial Statements
   
    2.       Financial Statement Schedules
   
             Schedule III - Real Estate and Accumulated Depreciation
   
    All other  schedules  for  which  provision  is made in the  applicable
    accounting regulation of the Securities and Exchange Commission are not
    required  under  the  related  instruction  or  are  inapplicable  and,
    therefore, have been omitted.
   
    3.      Listing of Exhibits
   
             3.1     Agreement of Limited  Partnership dated as of December
                     12,  1989,  and  amended  as  of  December  18,  1989,
                     February 19, 1990, and April 9, 1990, filed as Exhibit
                     3A to Amendment No.2 to the Partnership's Registration
                     Statement   on  Form  S-11  dated   April  23,   1990,
                     incorporated herein by reference.
   
             3.2     Amendment to Amended Agreement of Limited  Partnership
                     dated as of February 8, 1993,  filed as Exhibit 3.3 to
                     the Partnership's 10-K for the year ended December 31,
                     1992, and incorporated herein by reference.
   
             3.3     Amendment to Amended Agreement of Limited  Partnership
                     dated as of May 26, 1993,  filed as Exhibit 3.3 to the
                     Partnership's  10-K for the year  ended  December  31,
                     1993, and incorporated herein by reference.


                                      30
<PAGE>
 
             3.4     Amendment to Amended Agreement of Limited  Partnership
                     dated as of June 1, 1993,  filed as Exhibit 3.4 to the
                     Partnership's  10-K for the year  ended  December  31,
                     1993, and incorporated herein by reference.
             
             3.5     Amendment to Amended Agreement of Limited  Partnership
                     dated as of June 30, 1994, filed as Exhibit 3.5 to the
                     Partnership's  10-K for the year  ended  December  31,
                     1994, and incorporated herein by reference.
             
             0.0     Permanent Manager Agreement filed as an exhibit to the
                     Current  Report on Form 8-K dated  January  22,  1993,
                     incorporated herein by reference.
             
             9.0     Correspondence  to the Limited Partners dated February
                     15,   1999,   regarding   the  Fourth   Quarter   1998
                     distribution.
             
(b)          Report on Form 8-K:
             
             The Registrant  filed no reports on Form 8-K during the fourth
             quarter of fiscal year 1998.

                                      31
<PAGE>
 
                 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
             SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1998

<TABLE>
<CAPTION>



                                                                                             Gross amount at which
                                                 Initial cost to Partnership               carried at end of year (A)
                                                                                                                                   
                                                                                                                                   
                                                                                                                                   
                                                          Building                        Building                                 
                                                             and                            and                       Accumulated  
           Property           Encumbrances     Land      Improvements       Land         Improvements      Total      depreciation 
-----------------------------------------------------------------------------------------------------------------------------------

Pittsburgh, Pennsylvania            -      $  274,467     $  616,866     $  274,467      $  616,866      $ 891,333     $ 175,952   
St. Francis, Wisconsin              -         485,354        709,028        468,354         606,153      1,074,507       204,506   
Oak Creek, Wisconsin                -         496,505        845,400        496,505         547,901      1,044,406       224,407   
Englewood, Colorado                 -               -        213,210              -         213,210        213,210        52,271   
Colorado Springs, Colorado          -         314,354        265,829        314,354         265,829        580,183        56,260   

                            ----------------------------------------------------------------------------------------------------

<S>                               <C>      <C>            <C>            <C>             <C>            <C>             <C>     
                                  $ 0      $1,570,680     $2,650,333     $1,553,680      $2,249,959     $3,803,639      $713,396
                            ====================================================================================================
</TABLE>

<TABLE>
<CAPTION>

                              
                                                       Life on which      
                                                        depreciation      
                                                     in latest statement  
                                                       of operations      
                                 Date of       Date      is computed      
           Property            construction  acquired      (years)        
--------------------------------------------------------------------------
<S>                               <C>          <C>          <C>              
Pittsburgh, Pennsylvania          1990         9/11/90      31.5             
St. Francis, Wisconsin            1990         8/14/90      31.5             
Oak Creek, Wisconsin              1991          2/5/91      31.5             
Englewood, Colorado               1991          7/1/91      31.5             
Colorado Springs, Colorado         -           4/28/92      31.5  
</TABLE>

(A) Represents aggregate costs for federal income tax purposes.

(B) Reconciliation of "Real Estate and Accumulated Depreciation":
<TABLE>
<CAPTION>



                                        Year ended                Year ended                  
Investments in Real Estate          December 31, 1998         December 31, 1997               
---------------------------------  ----------------------  ------------------------           
<S>                                           <C>                       <C>                   
Balance at beginning of year                  $ 5,340,446               $ 5,848,562           
Property write-down                             (400,374)                         0           
                                                                                              

                                                                                              
                                                                                              
Sale of Property                              (1,136,433))                (508,116)
                                   ----------------------  ------------------------

Balance at end of year                         $3,803,639                $5,340,446           
                                   ======================  ========================           

</TABLE>

<TABLE>
<CAPTION>
                                          Year ended                Year ended       
Accumulated Depreciation              December 31, 1998         December 31, 1997    
---------------------------------  ------------------------  ------------------------
<S>                                        <C>                         <C>      
Balance at beginning of year               $ 761,861                   $ 761,761
Additions charged to costs                                                      
  and expenses                                84,103                     110,951
                                                                                
Sale of Property                           (132,568)                   (110,851)
                                   -----------------         -------------------
                                                                                
                                                                                
                                                                                
Balance at end of year                      $713,396                    $761,861
                                   =================         ===================
</TABLE>                                                      
                                                      
                                       32
<PAGE>
 
                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its
behalf by the undersigned, thereunto duly authorized.



DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP



By:      The Provo Group, Inc., General Partner



By:      /s/Bruce A. Provo
         ---------------------------------
         Bruce A. Provo, President


Date:    March 26, 1999


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities and on the dates indicated.



By:      The Provo Group, Inc., General Partner



By:      /s/Bruce A. Provo
         ---------------------------------
         Bruce A. Provo, President


Date:    March 26, 1999



By:      /s/Kristin J. Atkinson
         ---------------------------------
         Kristin J. Atkinson
         Vice President - Finance and Administration


Date:    March 26, 1999


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