UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESx EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to Commission file number 0-20164 Krupp Government Income Trust II (Exact name of registrant as specified in its charter) Massachusetts 04-3073045 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 470 Atlantic Avenue, Boston, Massachusetts 02210 (Address of principal executive offices) (ZipCode) (Registrant's telephone number, including area code) (617)423-2233 Securities registered pursuant to Section 12(b) of the Act: Title Name of Exchange on which Registered Shares of Beneficial Interest None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No 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. [ ]. Aggregate market value of voting securities held by non-affiliates: Not applicable. Documents incorporated by reference: see Part IV, Item 14 The exhibit index is located on pages 10-19. PART I This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, including those identified herein. ITEM 1. BUSINESS Krupp Government Income Trust II (the "Trust") is a Massachusetts business trust which was formed on February 8, 1991 and is authorized to sell up to 25,000,000 shares of beneficial interest (the "Shares"). Berkshire Realty Advisors Limited Partnership acquired 10,000 of such Shares and 18,315,158 Shares were sold under the Trust's public offering for $365,686,058 net of purchase volume discounts of $617,102. On December 29, 1994, Berkshire Mortgage Advisors Limited Partnership acquired Berkshire Realty Advisors Limited Partnership's 10,000 shares and assumed the role of the Advisor to the Trust. Under the Dividend Reinvestment Plan ("DRP"), 46,319 Shares were sold for $880,061 (the remaining 6,572,204 Shares are available for general Trust purposes). See Note A of Notes to Financial Statements included in Appendix A of this report for additional information. The Trust has utilized the net proceeds from the public offering to acquire participating insured mortgages ("PIMs"), participating insured mortgage investments ("PIMIs") and mortgage-backed securities ("MBS"). The Trust considers itself to be engaged in only one industry segment, investment in mortgages. The Trust has elected to be treated as a real estate investment trust ("REIT"), under the Internal Revenue Code of 1986, as amended. The Trust shall terminate on December 31, 2030, unless earlier terminated by the affirmative vote of holders of a majority of the outstanding shares entitled to vote thereon. See Note A of Notes to Financial Statements included in Appendix A of this report for additional information. The Trust's investments in PIMs on multi-family residential properties consist of a MBS or an insured mortgage loan (collectively, the "insured mortgage") guaranteed or insured as to principal and basic interest and a participation interest. The insured mortgages were issued or originated under or in connection with the housing programs of the Federal National Mortgage Association ("FNMA") or Federal Housing Administration ("FHA") under the authority of the Department of Housing and Urban Development ("HUD"). PIMs provide the Trust with monthly payments of principal and basic interest and may also provide for Trust participation in the current revenue stream and in the residual value, if any, from a sale or other realization of the underlying property. The borrower conveys these rights to the Trust through a subordinated promissory note and mortgage. The participation features are neither insured nor guaranteed. The PIMIs consist of an insured mortgage, as discussed above, and an additional loan ("Additional Loan") to the borrower or owners of the borrower in excess of mortgage amounts insured under GNMA, FNMA or FHA programs that increases the Trust's total financing with respect to that property and participation in cash generated by property operations and any appreciation in the value of the property. The participation features related to all PIMIs are neither insured nor guaranteed. Additional Loans associated with insured mortgages issued or originated under or in connection with HUD cannot, under government regulations, be collateralized by a mortgage on the underlying property. These Additional Loans are typically collateralized with collateral satisfactory to the Advisor, but are neither insured nor guaranteed. Additional Loans associated with FNMA insured mortgages are collateralized by a subordinated mortgage on the underlying property. The borrower conveys these rights to the Trust through a subordinated loan agreement. Under the Additional Loans, the Trust receives semi-annual interest payments and a Preferred Return representing a non-compounded cumulative return on the outstanding indebtedness, usually the aggregate amount of the insured mortgage and Additional Loan. Prior to December 27, 1998 the Trust can reinvest principal proceeds received from its mortgage investments in new mortgages. Any reinvestment in mortgages will be based on management's evaluation of market conditions for participating mortgages. When the reinvestment period ends, the Trust will distribute proceeds from prepayments or other realizations of mortgage assets to investors either through quarterly distributions or possibly special distributions. The Trust also acquired MBS collateralized by single-family mortgage loans issued or originated by FNMA or the Federal Home Loan Mortgage Corporation ("FHLMC"). FNMA and FHLMC guarantee the principal and interest of the FNMA and FHLMC MBS, respectively. Although the Trust will terminate no later than December 31, 2030, the value of the PIMIs and PIMs may be realized by the Trust through repayment or sale as early as ten years from the dates of the closings of the permanent loans, and the Trust may realize the value of all of its other investments within that time frame thereby resulting in a dissolution of the Trust significantly prior to December 31, 2030. The requirements for compliance with federal, state and local regulations to date have not had an adverse effect on the Trust's operations, and the Trust anticipates no adverse effect in the future. To qualify as a REIT for federal income tax purposes, the Trust made a valid election to be so treated and must continue to satisfy a range of complex requirements including criteria related to its ownership structure, the nature of its assets, the sources of its income and the amount of its distributions to shareholders. The Trust intends to qualify as a REIT in each year of operation, however, certain factors may have an adverse effect on the Trust's REIT status. If for any taxable year, the Trustees and the Advisor determine that any of the asset, income, or distribution tests are not likely to be satisfied, the Trust may be required to borrow money, dispose of mortgages or take other action to avoid loss of REIT status. Additionally, if the Trust does not qualify as a REIT for any taxable year, it will be subject to federal income tax as if it were a corporation and the shareholders will be taxed as shareholders of a corporation. If the Trust were taxed as a corporation, the payment of such tax by the Trust would substantially reduce the funds available for distribution to shareholders or for reinvestment. To the extent that distributions had been made in anticipation of the Trust's qualification as a REIT, the Trust might be required to borrow additional funds or to liquidate certain of its investments in order to pay the applicable tax. Moreover, should the Trust's election to be taxed as a REIT be terminated or voluntarily revoked, the Trust may not be able to elect to be treated as a REIT for the following five-year period. As of December 31, 1997, there were no personnel directly employed by the Trust. ITEM 2. PROPERTIES None. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings to which the Trust is a party or to which any of its investments are subject to. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Currently there is no established public trading market for the Shares. The number of investors holding Shares as of December 31, 1997 was approximately 15,500. The Trust has and intends to continue to declaring and paying dividends on a quarterly basis. The Trustees established a dividend rate per Share per quarter of $.3125 for 1997 and 1996. ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial information regarding the Trust's financial position and operating results. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements and Supplementary Data, which are included in Item 7 and Item 8, Appendix A of this report, respectively. (Amounts in thousands, except for per Share amounts) 1997 1996 1995 1994 1993 Total revenues $ 21,291 $ 19,877 $ 20,033 $ 18,200 $ 15,867 Net income $ 16,263 $ 14,999 $ 13,747 $ 13,882 $ 13,853 Net income per Share $ .89 $ .82 $ .75 $ .76 $ .75 Weighted average Shares outstanding 18,371 18,371 18,371 18,371 18,364 Total assets at December 31 $293,158 $298,297 $306,965 $314,250 $322,855 Average dividends per Share $ 1.25 $ 1.25 $ 1.25 $ 1.25 $ 1.60 The Trust completed its public offering in 1993, therefore the Selected Financial Data for 1993 is not indicative of the Trust's future results and is not comparable with 1997, 1996, 1995 and 1994. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements including those concerning Management s expectations regarding the future financial performance and future events. These forward-looking statements involve significant risk and uncertainties, including those described herein. Actual results may differ materially from those anticipated by such forward-looking statements. Liquidity and Capital Resources At December 31, 1997, the Trust has liquidity consisting of cash and cash equivalents, of approximately $13.5 million as well as the cash inflows provided by PIMs, PIMIs, MBS, cash and cash equivalents. The Trust may also receive additional cash flow from the participation features of its PIMs and PIMIs. The Trust anticipates that these sources will be adequate to provide the Trust with sufficient liquidity to meet its obligations, including providing dividends to its investors. The most significant demand on the Trust's liquidity are dividends paid to investors which currently approximate $23.0 million per year ($5.75 million per quarter). For 1997, the Trust declared an annual dividend of $1.25 per share, paid in quarterly installments of $.3125 per share. Funds for dividends come from interest income received on PIMs, PIMIs, MBS and cash and cash equivalents net of operating expenses, and the principal collections received on PIMs, PIMIs and MBS. The portion of dividends funded from principal collections reduces the capital resources of the Trust. As the capital resources of the Trust decrease, the total cash flows to the Trust will also decrease which may result in periodic adjustments to the dividends paid to the investors. The Advisor of the Trust periodically reviews the dividend rate to determine whether an adjustment to the dividend rate is necessary based on projected future cash flows. Based on current projections, the Advisor believes the Trust can maintain the current dividend rate for the foreseeable future. In general, the Advisor tries to set a dividend rate that provides for level quarterly distribution. To the extent quarterly dividends do not fully utilize the cash available for distribution and cash balances increase, the Advisor may reinvest the available proceeds, adjust the dividend rate or distribute such funds through a special distribution. During the second quarter of 1997, the Trust funded an additional $465,000 to the owner of the Willows Apartments increasing the Additional Loan amount to $1,265,000. Subsequent to the funding, the owner notified the Trust of its intention to sell the property to a third party during the third quarter. During the third quarter of 1997, the Trust received the prepayment of the Additional Loan of $1,265,000 and the payment of $789,336 which represents all of the Preferred Interest due on the Trust s investment through the date of sale. In addition the Trust allowed the purchaser to assume the first mortgage. The Trust converted the Willows Apartment PIMI to an insured mortgage. Many of the properties had stable or improving performances in 1997. All but one of the underlying properties with stabilized operations had high average 1997 occupancies, generally between 90% and 100%. Windmill Lakes is located in a South Florida county that has seen a significant housing boom, both in newly constructed multifamily projects as well as single family development. Windmill Lakes operating performance during the third quarter continued to be adversely affected by the highly competitive housing market in Pembroke Pines, Florida. New construction in all housing sectors is being fueled by strong job and population growth in the area. Builders marketing concessions to fill new properties lowers the cost of renting a new apartment and makes it more difficult for older properties like Windmill Lakes to attract residents. The borrower has informed the Advisor that the property is being marketed for sale. Should the borrower be unable to obtain a purchase offer adequate to cover the property s outstanding liabilities, the Advisor anticipates that some measure of debt service relief will be necessary until the market stabilizes. The Advisor continues to monitor this property closely. Two other properties moved towards stabilized occupancy during 1997 after completing construction. Mill Pond II reached 95% by year-end, and Norumbega Point completed the initial lease-up of the assisted living community by reaching 100% occupancy by year-end. Two other recently completed properties, the Fountains Apartments and Rivergreens II Apartments, faced more challenging lease-ups due to over saturated markets but achieved occupancy in the mid 90% range by year end. Rental rate increases were achieved at more than half of the properties due to stable or improving markets or the unique character of the specific property. During the third quarter the borrower on the Estates PIM informed the Advisor that a sale to one of the Trust s affiliated entities of the property was pending. To facilitate the sale transaction, the borrower asked and the Advisor agreed to release the participation features of the PIM and allow the purchaser to assume the obligations of the first mortgage loan. In exchange for this modification, the Advisor required the borrower to pay a settlement of $232,000 to provide the Trust with a financial return that will be comparable to what the Trust would have expected to receive had the borrower continued to own the property. The PIM was converted to an insured mortgage when the transaction was completed during the fourth quarter of 1997. In addition to funding its quarterly dividends paid to investors the Trust has a remaining commitment of approximately $1.0 million on a PIM in the construction phase. The Trust has sufficient cash reserves to fund this commitment. For the first five years of the PIMs and PIMIs the borrowers are prohibited from prepaying of loans. For the second five years, the borrowers can prepay the loans by incurring a prepayment penalty for PIMs or paying all amounts due under the PIMIs and satisfying the required preferred return. The Trust has the option of calling certain PIMs and all the PIMIs by accelerating their maturity if the loans are not prepaid by the tenth year after permanent funding. The Trust will determine the merits of exercising the call option for each PIM or PIMI as economic conditions warrant. Such factors as the condition of the asset, local market conditions, interest rates and available financing will have an impact on this decision. Assessment of Credit Risk The Trust's investments in mortgages, with the exception of the Additional Loans, are guaranteed or insured by FNMA, FHLMC or HUD, and therefore, the risk of a material loss of amounts invested is remote. The certainty of principal on the Trust's investments primarily depends upon the creditworthiness of these entities. FNMA is a federally chartered private corporation that guarantees obligations originated under its programs. However, obligations of FNMA are not backed by the U.S. Government. FNMA is one of the largest corporations in the United States and the Secretary of the Treasury of the United States has discretionary authority to lend up to $2.25 billion to FNMA at any time. FHLMC is a federally chartered corporation that guarantees obligations originated under its programs and is wholly-owned by the twelve Federal Home Loan Banks. These obligations are not guaranteed by the U.S. Government or the Federal Home Loan Bank Board. HUD, an agency of the U.S. Government, insures the obligations originated under its programs which are backed by the full faith and credit of the U.S. Government. The Trust's Additional Loans have similar risks as those associated with higher risk debt instruments, including: reliance on the owner's operating skills and their ability to maintain occupancy levels, including control of operating expenses, maintain properties and obtain adequate insurance coverage; adverse changes in general economic conditions, adverse local conditions, and changes in governmental regulations, real estate zoning laws, or tax laws; and other circumstances over which the Trust may have little or no control. The Trust includes in cash and cash equivalents approximately $10 million of commercial paper, which is issued by entities with a credit rating equal to one of the top two rating categories of a nationally recognized statistical rating organization. Operations (amounts in thousands, except per Shareamounts) Year Ended December 31, 1997 1996 1995 Per Per Per Amount Share Amount Share Amount Share Interest on PIMs: Base interest $13,828 $ .75 $13,952 $.76 $12,371 $.67 Additional loan interest 2,147 .12 1,522 .08 1,474 .08 Participation interest 1,770 .10 768 .04 422 .02 Interest income on MBS 2,847 .16 3,123 .17 4,616 .25 Interest income - other 698 .04 512 .03 1,150 .06 Trust Expenses (2,840) (.16) (2,783) (.15) (2,997) (.15) Loss on sale of MBS - - - - (1,379) (.08) Amortization of prepaid fees and expenses and organization costs (2,187) (.12) (2,095) (.11) (1,910) (.10) Net income $16,263 $ .89 $14,999 $.82 $13,747 $.75 Weight Average Shares Outstanding 18,371,477 18,371,477 18,371,477 The net income of the Trust for 1997 increased as compared to 1996 and 1995. During the three years ended December 31, 1997 the Trust's operations underwent significant changes in the mix of interest income as the Trust continued to invest in PIMs and PIMIs during 1996 and 1995. Interest income from PIMs and PIMIs increased by approximately $1,503,000 in 1997 as compared to 1996 and approximately $1,975,000 in 1996 as compared to 1995 due to the investments in PIMs and PIMIs made during 1995. The Trust s total interest income for 1997 as compared to 1996 increased by approximately $1,413,000 due to higher Additional Loan interest, Participation interest and interest income other, which was partially offset by decreases in interest income on MBS and base interest on PIMs and PIMIs. The increases in Additional Loan interest and Participation interest was primarily due to the Trust receiving participation appreciation interest of approximately $789,000 from the preferred return payment related to the Willows Additional Loan payoff and Participation income interest of approximately $980,000 from 10 of its PIMs and PIMIs, as compared to $768,000 from seven of its PIMs and PIMIs in 1996. Management expects the strong operating performances of Crossings Village, Martin's Landing, St. Germain, The Lakes and Windsor Lakes will continue and the Trust will continue to receive Participation income interest. The Seasons, which was completely renovated in 1994 and 1995, performed very well during 1996 and 1997. As a result of this in 1997, the Trust began recognizing additional loan income and Participation interest income from The Seasons and management expects it to continue to do so in 1998. This was offset by a decrease in interest income on MBS and base interest on PIMs and PIMIs. Interest income on MBS and base interest on PIMs and PIMIs will continue to decline as principal collections reduce the outstanding balance of the MBS, PIM and PIMI portfolios. The Trust s expenses increased by approximately $57,000 or 2% in 1997 as compared to 1996 primarily due to an increase in expense reimbursements and general and administrative expense. This was offset by lower asset management fees resulting from a declining asset base when comparing 1997 to 1996. The Trust s total interest income for 1996 as compared to 1995 decreased by approximately $156,000, due to lower interest income on MBS and interest income other, which was partially offset by increases in interest income on PIMs. Interest income on PIMs increased due to additional investments in PIMs and PIMIs. Interest income-other and interest income on MBS decreased as the Trust used available cash to fund its commitments in PIMs and PIMIs, and funded a portion of its dividends with principal collections. To the extent the Trust uses principal collections to fund a portion of the dividend it will continue to reduce the income generating assets of the Trust, which could reduce interest income in the future. Trust expenses, exclusive of losses from the sale of MBS, decreased by $214,000 in 1996 versus 1995 as a result of decreases in expenses reimbursements, lower asset management fees and reduced general and administrative expenses. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Appendix A to this report. 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 Information as to the Trustees and Executive Officers of Krupp Government Income Trust II is as follows: Position with Krupp -10- Name and Age Government Income Trust II Douglas Krupp (51) Chairman of Board of Trustees and Trustee * Charles N. Goldberg (56) Trustee * E. Robert Roskind (52) Trustee * J. Paul Finnegan (72) Trustee Robert A. Barrows (40) Treasurer Scott D. Spelfogel (37) Clerk K. Scott Griggs (35) Assistant Clerk * Independent Trustee Douglas Krupp is Co-Founder and Chairman of The Berkshire Group. Established in 1969 as the Krupp Companies and headquartered in Boston, the Berkshire Group is a privately held real estate-based firm that has expanded over the years within its areas of expertise including investment program sponsorship, property and asset management, mortgage banking and healthcare facility management. The Berkshire Group s interests include ownership of a mortgage company specializing in commercial mortgage financing with a portfolio of approximately $4.5 billion. In addition, The Berkshire Group has a majority ownership interest in Harborside Healthcare (NYSE-HBR), a long-term and subacute care company and a significant ownership interest in Berkshire Realty Company, Inc. (NYSE-BRI), a real estate investment trust specializing in apartment investments. Mr. Krupp is a graduate of Bryant College. In 1989 he received an honorary Doctor of Science in Business Administration from this institution and was elected trustee in 1990. Mr. Krupp is Chairman of the Board and a Director of both Berkshire Realty Company, Inc. and Harborside Healthcare. Mr. Krupp also serves as Chairman of the Board and Trustee of Krupp Government Income Trust. Charles N. Goldberg is of counsel to the law firm of Broocks, Baker & Lange, L.L.P. Prior to joining Broocks, Baker & Lange, L.L.P., Mr. Goldberg was a partner in the law firm of Hirsch & Westheimer from March of 1996 to December of 1997. Prior to Hirsch & Westheimer, he was the Managing Partner of Goldberg Brown, Attorneys at Law from 1980 to March of 1996. He currently serves as a Trustee of Krupp Government Income Trust. He is also currently a director of Berkshire Realty Company, Inc. (NYSE- BRI). He received a B.B.A. degree and a J.D. degree from the University of Texas. He is a member of the State Bar of Texas and is admitted to practice before the U.S. Court of Appeals, Fifth Circuit and U.S. District Court, Southern District of Texas. E. Robert Roskind is the Chairman and Co-Chief Executive Officer of Lexington Corporate Properties, a self-administered REIT, the shares of which are listed on the NYSE. Mr. Roskind is also the Managing Partner of The LCP Group, a real estate investment firm based in New York, the predecessor of which he co-founded in 1974. He currently serves as a Trustee of Krupp Government Income Trust. He is also currently a director of Berkshire Realty Company, Inc. (NYSE-BRI). Mr. Roskind holds a B.A. degree from the University of Pennsylvania and a J.D. degree from Columbia Law School. He has been a member of the New York Bar since 1970. J. Paul Finnegan retired as a partner of Coopers & Lybrand in 1987. Since then, he has been engaged in business as a consultant, a director and arbitrator. Mr. Finnegan holds a B.A. degree from Harvard College, a J.D. degree from Boston College Law School and an ASA from Bentley College. Mr. Finnegan currently serves as a Trustee of Krupp Government Income Trust. He is also currently a director at Scituate Federal Savings Bank and a director of Berkshire Realty Company, Inc. (NYSE-BRI). Mr. Finnegan is a Certified Public Accountant and an attorney. Robert A. Barrows is the Treasurer of the Trust and is Senior Vice President and Chief Financial Officer of Berkshire Mortgage Finance. Mr. Barrows has held several positions within The Berkshire Group since joining the company in 1983 and is currently responsible for accounting, financial reporting, treasury, management information systems and loan closing and servicing for Berkshire Mortgage Finance. Prior to joining The Berkshire Group, he was an audit supervisor for Coopers & Lybrand L.L.P. in Boston. He received a B.S. degree from Boston College and is a Certified Public Accountant. Scott D. Spelfogel is the Clerk of the Trust and is Senior Vice President and General Counsel to The Berkshire Group. He previously served as Vice President and Assistant General Counsel. Before joining the firm in November 1988, he was a litigator in private practice in Boston. He received a Bachelor of Science degree in Business Administration from Boston University, a Juris Doctor Degree from Syracuse University's College of Law, and a Master of Laws degree in Taxation from Boston University Law School. He is admitted to practice law in Massachusetts and New York, is a member of the American, Boston, Massachusetts and New York State bar associations, the American Corporate Counsel Association and the American Society of Corporate Secretaries and is a licensed real estate broker in Massachusetts. K. Scott Griggs is the Assistant Clerk of the Trust and the Vice President and Assistant General Counsel of The Berkshire Group. Before joining The Berkshire Group in March 1991, he served as counsel to The Fafard Companies, a construction and real estate firm in Greater Boston. He received a B.A. degree from Columbia University in 1984 and a J.D. degree from the Boston University School of Law in 1989. He is a member of the American Bar Association, Massachusetts Bar Association and the Boston Bar Association. In addition, the following are deemed to be Executive Officers of the registrant: George Krupp (age 53) is the Co-Founder of The Berkshire Group. Established in 1969 as the Krupp Companies and headquartered in Boston, the Berkshire Group is a privately held real estate-based firm that has expanded over the years within its areas of expertise including investment program sponsorship, property and asset management, mortgage banking and healthcare facility management. The Berkshire Group s interests include ownership of a mortgage company specializing in commercial mortgage financing with a portfolio of approximately $4.5 billion. In addition, The Berkshire Group has a majority ownership interest in Harborside Healthcare (NYSE-HBR), a long-term and subacute care company and a significant ownership interest in Berkshire Realty Company, Inc. (NYSE-BRI), a real estate investment trust specializing in apartment investments. Mr. Krupp received his undergraduate education from the University of Pennsylvania and Harvard University Extension School and holds a Master s Degree in History from Brown University. -12- Peter F. Donovan (age 44) is Chief Executive Officer of Berkshire Mortgage Finance and overseas the strategic growth plans of this mortgage banking firm which is the 12th largest in the United States based on servicing and asset management of a $4.5 billion loan portfolio. Previously he served as President of Berkshire Mortgage Finance and directed the production underwriting and servicing and asset management activities of the firm. Prior to that, he was Senior Vice President of Berkshire Mortgage Finance and was responsible for all participating mortgage originations. Before joining the firm in 1984, he was Second Vice President, Real Estate Finance for Continental Illinois National Bank & Trust, where he managed a $300 million construction loan portfolio of commercial properties. Mr. Donovan received a B.A. from Trinity College and an M.B.A. degree from Northwestern University. ITEM 11. EXECUTIVE COMPENSATION Except for the Independent Trustees as described below, the Trustees and Officers of the Trust have not been and will not be compensated by the Trust for their services. However, the Officers will be compensated by the Advisor or an affiliate of the Advisor. Compensation of Trustees The Trust paid each of the Independent Trustees a fee of $25,000 in 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of February 5, 1997, no person owned of record or was known by the Advisor to own beneficially more than 5% of the Trust's 18,371,477 outstanding Shares. The only Shares held by the Advisor or any of its affiliates consist of the original 10,000 Shares held by the Advisor. Class of Name of Beneficial Amount and Nature of Percent Stock Owner Beneficial Interest of Class Shares of Douglas Krupp Beneficial 470 Atlantic Avenue Interest Boston, Ma. 02210 10,000 Shares** *** Shares of Beneficial Interest All Directors and 10,000 Shares *** Officers ** Mr. Krupp is a beneficial owner of the 10,000 shares held by Berkshire Mortgage Advisors Limited Partnership, the Advisor to the Company, by virtue of being a director of Berkshire Funding Corporation, the general partner of Berkshire Mortgage Advisors Limited Partnership. In each case where Mr. Krupp is a beneficial owner of shares he has shared voting and investment powers. -13- *** The amount owned does not exceed one percent of the shares of beneficial interest of the Trust outstanding as of February 5, 1998. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS See Note G to Financial Statements included in Appendix A of this report. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)1. Financial Statements - see Index to Financial Statements and Supplementary Data included under Item 8, Appendix A, on page F-2 of this report. 2. Financial Statement Schedules - see Index to Financial Statements and Supplementary Data included under Item 8, Appendix A, on page F-2 of this report. All schedules are omitted as they are not applicable, not required or the information is provided in the Financial Statements or the Notes thereto. (b) Exhibits: Number and Description Under Regulation S-K The following reflects all applicable Exhibits required under Item 601 of Regulation S-K: (4) Instruments defining the rights of security holders including indentures: (4.1) Fourth Amended and Restated Declaration of Trust filed with The Massachusetts Secretary of State on September 25, 1991 [Included as Exhibit 4.8 to Post-effective Amendment No. 1 to Registrant's Registration Statement on Form S-11 dated September 26, 1991 (File No. 33-39033)].* (4.2) Subscription Agreement Specimen [Included as Exhibit C to Prospectus included in Post-effective Amendment No. 1 to Registrant's Registration Statement on Form S-11 dated September 26, 1991 (File No. 33-39033)].* (10) Material Contracts (10.1) Advisory Services Agreement dated September 11, 1991 between Krupp Government Income Trust II and Berkshire Realty Advisors Limited Partnership (formerly known as Krupp Realty Advisors Limited Partnership)[Exhibit 10.1 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.2) Assignment and Assumption Agreement between Berkshire Realty Advisors Limited Partnership and Berkshire Mortgage Advisors Limited Partnership [Exhibit 10.2 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0- 20164)].* Mequon Trails (10.3) Supplement to Prospectus dated January 1, 1993 for Federal National Mortgage Association pool number MX-073025 [Exhibit 19.1. to Registrant's Report on Form 10-Q for the quarter ended March 31, 1993 (File No. 0-20164)].* (10.4) Subordinated promissory note dated December 21, 1992 by and between Mequon Trails Townhomes Limited Partnership and Krupp Government Income Trust II [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1993 (File No. 0-20164)].* (10.5) Subordinate Multifamily Mortgage dated December 21, 1992 between Mequon Trails Townhomes Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.5 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.6) Subordination Agreement dated December 21, 1992 between Krupp Mortgage Company L.P., Krupp Government Income Trust II and Mequon Trails Townhomes Limited Partnership.[Exhibit 10.6 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* The Estates (10.7) Deed of Trust Note dated May 14, 1993 for The Estates [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1993.[Exhibit 10.7 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.8) Deed of Trust dated May 14, 1993 for The Estates Limited Partnership and Maryland National Mortgage Corporation.[Exhibit 10.8 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.9) Multifamily Deed of Trust, Assignment of Rents and Security Agreement dated May 14, 1993 between The Estates Limited Partnership and Krupp Government Income Trust.[Exhibit 10.9 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.10) Subordinated Promissory Note, dated May 14, 1993, between Maryland National Mortgage Corporation and Krupp Government Income Trust.[Exhibit 10.10 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.11) Participation and Servicing Agreement dated May 14, 1993 by and between Maryland National Mortgage Corporation and Krupp Government Income Trust II [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 0- 20164)].* The Seasons (10.12) Subordinated Promissory Note, dated September 16, 1993, between Maryland Associates Limited Partnership and Krupp Government Income Trust [Exhibit 10.1 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 0-20164)].* (10.13) Additional Loan Agreement dated September 16, 1993 between the Krupp Company Limited Partnership-IV and Krupp Government Income Trust II [Exhibit 10.2 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1993 (file No. 0- 20164)].* (10.14) Additional Loan Note dated September 16, 1993, between the Krupp Company Limited Partnership-IV and Krupp Government Income Trust II [Exhibit 10.3 to Registrant's Report on form 10-Q for the quarter ended September 30, 1993 (File No. 0- 20164)].* (10.15) Participation and Servicing Agreement dated September 16, 1993 by and between Krupp Mortgage Corporation and Krupp Government Income Trust-II [Exhibit 10.4 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1993 (File No.0-20164)].* (10.16) Deed of Trust Note dated September 16, 1993 for Maryland Associates Limited Partnership and Krupp Mortgage Corporation [Exhibit 10.11 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.17) Assignment and Assumption Agreement dated September 16, 1993 between Krupp Government Income Trust II and Krupp Government Income Trust [Exhibit 10.12 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0- 20164)].* (10.18) Agreement re Subordinated Note dated September 16, 1993 between Krupp Mortgage Corporation and Krupp Government Income Trust II [Exhibit 10.13 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* Martin's Landing (10.19) Subordinated Loan Agreement, dated November 9, 1993, between TRC Realty Incorporated - ML, ML Associates Limited Partnership ("Borrower") and Krupp Government Income Trust II ("Holder") [Exhibit 10.9 to Registrant's annual report on Form 10-K for fiscal year ended December 31, 1993 (File No. 0-20164)].* (10.20) Subordination Agreement dated November 9, 1993 between ML Associates, L.P., and Krupp Government Income Trust II.[Exhibit 10.22 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.21) Assignment of Subordination Agreement dated November 9, 1993 from Berkshire Mortgage Finance Limited Partnership to the Federal National Mortgage Association by and between ML Associates, L.P., Berkshire Mortgage Finance Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.23 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.22) Supplement to Prospectus dated December 1, 1993 for Federal National Mortgage Association pool number MX - 073029.[Exhibit 10.24 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* Crossings Village (10.23) Subordinated Loan Agreement, dated September 28, 1993 between Crossings Village Westlake Associates ("Borrower") and Krupp Government Income Trust II ("Holder")[Exhibit 10.10 to Registrant's annual report on Form 10-K for fiscal year ended December 31, 1993 (File No. 0-20164)].* (10.24) Subordinated Note dated September 28, 1993 between Crossings Village Westlake Associates and Krupp Government Income Trust II [Exhibit 10.16 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* -17- (10.25) Subordination Agreement dated September 28, 1993 between Washington Capital DUS Inc., Crossings Village Westlake Associates and Krupp Government Income Trust II.[Exhibit 10.27 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* Norumbega Point (10.26) Subordinated Promissory Note, dated December 14, 1993 between Longa Vita Corporation ("Maker or Mortgagor") and Krupp Government Income Trust II ("Holder")[Exhibit 10.11 to Registrant's annual report on Form 10-K for fiscal year ended December 31, 1993 (File No. 0-20164)].* (10.27) Additional Loan Note dated December 14, 1993 between Evelyn Insoft, Sidney Insoft, Richard Slifka, and Alfred A. Slifka ("Borrowers") and Krupp Government Income Trust II ("Holder") [Exhibit 10.12 to Registrant's annual report on Form 10-K for fiscal year ended December 31, 1993 (File No. 0-20164)].* (10.28) Participation and Servicing Agreement dated December 14, 1993 by and between Cambridge Healthcare Funding, Inc. and Krupp Government Income Trust II.[Exhibit 10.30 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.29) Subordinated Multifamily Mortgage Assignment of Rents and Security Agreement dated December 14, 1993 between Longa Vita Corp. and Krupp Government Income Trust II.[Exhibit 10.31 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.30) Additional Loan Agreement dated December 14, 1993 between the Evelyn Insoft, Sidney Insoft, Richard Slifka and Alfred A. Silfka, Longa Vita Corp. and Krupp Government Income Trust II.[Exhibit 10.32 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.31) Mortgage Note dated December 14, 1993 between Longa Vita Corp. and Cambridge Healthcare Funding, Inc.[Exhibit 10.33 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.32) Agreement re Subordinated Note dated December 14, 1993 between Cambridge Healthcare Funding, Inc. and Krupp Government Income Trust II.[Exhibit 10.34 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* -18- Sunset Summit (10.33) Subordinated Loan Agreement dated November 24, 1993 between Sunset Summit Limited Partnership and Krupp Government Income Trust II [Exhibit 10.21 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.34) Subordinated Note dated November 24, 1993 between Sunset Summit Limited Partnership and Krupp Government Income Trust II [Exhibit 10.22 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.35) Subordination Agreement dated November 24, 1993 between BMFLP, Sunset Summit Limited Partnership and Krupp Government Income Trust II [Exhibit 10.23 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.36) Assignment of Subordination Agreement dated November 24, 1993 from Berkshire Mortgage Finance Limited Partnership to the Federal National Mortgage Association by and between Sunset Summit Limited Partnership, Berkshire Mortgage Finance Limited Partnership and Krupp Government Income Trust II [Exhibit 10.24 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.37) Subordinate Multifamily Mortgage Agreement dated November 24, 1993 between Sunset Summit Limited Partnership and Krupp Government Income Trust II [Exhibit 10.25 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0- 20164)].* (10.38) Supplement to Prospectus dated January 1, 1994 for Federal National Mortgage Association pool number MX - 073030 [Exhibit 10.26 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* Windsor Lake (10.39) Subordinated Loan Agreement dated June 16, 1994 between Cedar Lake L. P. and Krupp Government Income Trust II [Exhibit 10.27 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.40) Subordinate Note dated June 16, 1994 between Cedar Lake L. P. and Krupp Government Income Trust II [Exhibit 10.28 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.41) Subordination Agreement dated June 16, 1994 between Berkshire Mortgage Finance Limited Partnership, Cedar Lake L. P. and Krupp Government Income Trust II [Exhibit 10.29 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.42) Assignment of Subordination Agreement dated June 16, 1994 from Berkshire Mortgage Finance Limited Partnership to the Federal National Mortgage Association by and between, Cedar Lake L.P. and Berkshire Mortgage Finance Limited Partnership and Krupp Government Income Trust II [Exhibit 10.30 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.43) Subordinate Multifamily Deed to Secure Debt Agreement dated June 16, 1994 between Cedar Lake L.P. and Krupp Government Income Trust II [Exhibit 10.31 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.44) Supplement to Prospectus dated October 1, 1994 for Federal National Mortgage Association pool number MX - 073039 [Exhibit 10.32 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* Oasis at Springtree (10.45) Subordinate Note dated June 16, 1994 between Oasis at Springtree, Inc. and Krupp Government Income Trust II [Exhibit 10.33 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.46) Subordinated Loan Agreement dated August 11, 1994 between Joseph Kodsi and Albert Kodsi, Oasis at Springtree, Inc., and Krupp Government Income Trust II.[Exhibit 10.48 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.47) Subordination Agreement dated August 11, 1994 between Berkshire Mortgage Finance Limited Partnership, Oasis at Springtree, Inc. and Krupp Government Income Trust II.[Exhibit 10.49 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File. No 0-20164)].* (10.48) Assignment of Subordination Agreement dated August 11, 1994 for Berkshire Mortgage Finance Limited Partnership with Federal National Mortgage Association by and between Oasis at Springtree, Inc., Berkshire Mortgage Finance Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.50 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.49) Subordinated Multifamily Mortgage Assignment of Rents and Security Agreement dated August 11, 1994 between Oasis at Springtree, Inc. and Krupp Government Income Trust II.[Exhibit 10.51 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.50) Supplement to Prospectus dated January 1, 1994 for Federal National Mortgage Association pool number MX - 073043.[Exhibit 10.52 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* St Germain (10.51) Supplement to Prospectus dated April 1, 1994 for Federal National Mortgage Association pool number MX - 073031 [Exhibit 10.34 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.52) Subordinated Loan Agreement dated November 24, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II [Exhibit 10.35 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.53) Subordinate Note dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.55 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.54) Multifamily Mortgage Assignment of Rents and Security Agreement dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.56 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.55) Subordination Agreement dated December 17, 1993 between Berkshire Mortgage Finance Limited Partnership, Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.57 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.56) Supplement to Prospectus dated April 1, 1994 for Federal National Mortgage Association pool number MX - 073032 [Exhibit 10.36 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* -21- (10.57) Subordinated Loan Agreement dated November 24, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II [Exhibit 10.37 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.58) Subordinated Note dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.60 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.59) Multifamily Mortgage Assignment of Rents and Security Agreement dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.61 to Registrant s report form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.60) Subordination Agreement dated December 17, 1993 between Berkshire Mortgage Finance Limited Partnership, Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.62 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.61) Supplement to Prospectus dated April 1, 1994 for Federal National Mortgage Association pool number MX - 073033 [Exhibit 10.38 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.62) Subordinated Loan Agreement dated November 24, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II [Exhibit 10.39 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.63) Subordinated Note dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.65 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.64) Multifamily Mortgage Assignment of Rents and Security Agreement dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.66 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.65) Subordination Agreement dated December 17, 1993 between Berkshire Mortgage Finance Limited Partnership, Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.67 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.66) Supplement to Prospectus dated April 1, 1994 for Federal National Mortgage Association pool number MX - 073034 [Exhibit 10.40 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.67) Subordinated Loan Agreement dated November 24, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II [Exhibit 10.41 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* (10.68) Subordinated Note dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.70 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.69) Multifamily Mortgage Assignment of Rents and Security Agreement dated December 17, 1993 between Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.71 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.70) Subordination Agreement dated December 17, 1993 between Berkshire Mortgage Finance Limited Partnership, Abbey St. Germain Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.72 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* The Willows (10.71) Supplement to Prospectus dated January 1, 1994 for Federal National Mortgage Association pool number MX - 073057 [Exhibit 10.42 to Registrant's report on Form 10-K for the year ended December 31, 1994 (File No. 0-20164)].* Windmill Lakes (10.72) Subordinated Loan Agreement dated February 3, 1995 between Robert B. Kramer and Rose Berger, Windmill Lakes, Inc., and Krupp Government Income Trust II [Exhibit 10.1 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.73) Subordinate Note dated February 3, 1995 between Windmill Lakes, Inc., and Krupp Government Income Trust II [Exhibit 10.2 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.74) Subordinate Multifamily Mortgage Agreement dated February 3, 1995 between Windmill Lakes, Inc., and Krupp Government Income Trust II [Exhibit 10.3 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.75) Subordination Agreement dated February 3, 1995 by and among Green Park Financial Limited Partnership, Krupp Government Income Trust II and Windmill Lakes, Inc. [Exhibit 10.4 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* The Lakes (10.76) Subordinated Loan Agreement dated June 29, 1995, between Lake Associates, L. P. and Krupp Government Income Trust II [Exhibit 10.5 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.77) Subordinate Note dated June 29, 1995, between Lake Associates, L. P. and Krupp Government Income Trust II [Exhibit 10.6 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.78) Subordinate Multifamily Mortgage to Secure Debt Agreement dated June 29, 1995, between Lake Associates, L. P. and Krupp Government Income Trust II [Exhibit 10.7 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.79) Subordination Agreement dated June 29, 1995, between Berkshire Mortgage Finance Limited Partnership, Lake Associates, L. P. and Krupp Government Income Trust II [Exhibit 10.8 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.80) Assignment of Subordination Agreement dated June 29, 1995, from Berkshire Mortgage Finance Limited Partnership to the Federal National Mortgage Association by and between, Lake Associates, L.P. and Berkshire Mortgage Finance Limited Partnership and Krupp Government Income Trust II [Exhibit 10.9 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0- 20164)].* (10.81) Supplement to Prospectus dated November 1, 1994 for Federal National Mortgage Association pool number MX-073149 [Exhibit 10.10 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* The Fountains (10.82) Subordinated Promissory Note dated April 24, 1995 between CSM Fountains Limited Partnership and Krupp Government Income Trust II [Exhibit 10.11 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.83) Agreement Re: Subordinated Note dated April 24, 1995 between Berkshire Mortgage Finance Corporation and Krupp Government Income Trust II [Exhibit 10.12 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* (10.84) Subordinated Multifamily Mortgage Assignment of Rents and Security Agreement dated April 24, 1995 between CSM Fountains Limited Partnership and Krupp Government Income Trust II [Exhibit 10.13 to Registrant's report on Form 10-Q for the quarter ended September 30, 1995 (File No. 0-20164)].* Falls at Hunter Pointe (10.85) Additional Loan Note dated August 5, 1993 between Goulding L. Stoddard ("Borrower") and Krupp Government Income Trust ("Holder").[Exhibit 10.92 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.86) Additional Loan Agreement dated August 5, 1993 between Goulding L. Stoddard ("Borrower") and Krupp Government Income Trust("Holder").[Exhibit 10.93 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.87) Subordinated Promissory Note, dated August 4, 1993 between Hunters Pointe Associates, Ltd. ("Maker" or "Mortgagor") and Krupp Government Income Trust ("Holder").[Exhibit 10.94 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.88) Agreement re Subordinated Note dated August 5, 1993 between TRI Capital Corporation and Krupp Government Income Trust.[Exhibit 10.95 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.89) Subordinated Multifamily Deed of Trust, Assignment of Rents and Security Agreement dated August 5, 1993 between Hunters Pointe Associates, Ltd. and Krupp Government Income Trust.[Exhibit 10.96 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.90) Participation and Servicing Agreement dated August 5, 1993 by and between TRI Capital Corporation and Krupp Government Income Trust.[Exhibit 10.97 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* Rivergreens Apartments (10.91) Mortgage Note dated August 19, 1993 between Rivergreens Associates II Limited Partnership and Krupp Mortgage Company Limited Partnership.[Exhibit 10.98 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.92) Subordinated Promissory Note, dated August 19, 1993, between Rivergreens Associates II Limited Partnership and Krupp Government Income Trust.[Exhibit 10.99 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.93) Subordinated Multifamily Deed of Trust, Assignment of Rents and Security Agreement dated August 19, 1993 between Rivergreens Associates II Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.100 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* Mill Pond II Apartments (10.94) Mortgage Note dated July 26, 1994 for Mill Pond II Limited Partnership and Krupp Mortgage Company Limited Partnership.[Exhibit 10.101 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.95) Multifamily Subordinated Mortgage, Assignment of Rents and Security Agreement dated July 26, 1994 between Mill Pond II Limited Partnership and Krupp Government Income Trust II.[Exhibit 10.102 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* (10.96) Subordinated Promissory Note, dated July 26, 1994, between Mill Pond II Limited Partnership and Krupp Government Income Trust.[Exhibit 10.103 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* -26- (10.97) Agreement re Subordinated Note dated July 26, 1994, between Berkshire Mortgage Finance Corporation and Krupp Government Income Trust.[Exhibit 10.104 to Registrant s report on Form 10-K for the year ended December 31, 1995 (File No. 0-20164)].* * Incorporated by reference (c) Reports on Form 8-K The Trust did not file any reports on Form 8-K during the quarter ended December 31, 1997. -27- 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, on the 12th day of March, 1998. KRUPP GOVERNMENT INCOME TRUST II By: /s/ Douglas Krupp Douglas Krupp, Chairman of Board of Trustees and a Trustee of Krupp Government Income Trust II 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 indicated, on the 12th day of March, 1998. Signatures Title(s) /s/ Douglas Krupp Chairman of Board of Trustees and a Douglas Krupp Trustee of Krupp Government Income Trust II /s/ Robert A. Barrows Treasurer of Krupp Government Income Robert A. Barrows Trust II /s/ Charles N. Goldberg Trustee of Krupp Government Income Trust II Charles N. Goldberg /s/ E. Robert Roskind Trustee of Krupp Government Income Trust II E. Robert Roskind /s/ J. Paul Finnegan Trustee of Krupp Government Income Trust II J. Paul Finnegan -28- APPENDIX A KRUPP GOVERNMENT INCOME TRUST II FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ITEM 8 of FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION For the Year Ended December 31, 1997 KRUPP GOVERNMENT INCOME TRUST II INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Accountants F-3 Balance Sheets at December 31, 1997 and 1996 F-4 Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 F-5 Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 F-6 Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 F-7 Notes to Financial Statements F-8 - F-19 Supplementary Data - Selected Quarterly Financial Data (Unaudited) F-20 All schedules are omitted as they are not applicable or not required, or the information is provided in the financial statements or the notes thereto. F-2 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders of Krupp Government Income Trust II: We have audited the financial statements of Krupp Government Income Trust II (the "Trust") listed in the index on page F-2 of this Form 10-K. These financial statements are the responsibility of 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 these 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, these financial statements referred to above present fairly, in all material respects, the financial position of Krupp Government Income Trust II as of December 31, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Boston, Massachusetts March 9, 1998 KRUPP GOVERNMENT INCOME TRUST II BALANCE SHEETS December 31, 1997 and 1996 ASSETS 1997 1996 Participating Insured Mortgage Investments ("PIMIs")(Notes B, C and I): Insured mortgages $145,537,234 $150,454,030 Additional loans 29,152,351 29,952,351 Participating Insured Mortgages ("PIMs") (Notes B, D and I) 37,645,082 49,622,337 Mortgage-Backed Securities ("MBS") (Notes B, E and I) 51,171,301 40,581,650 Total mortgage investments 263,505,968 270,610,368 Cash and cash equivalents (Notes B and I) 13,520,091 9,214,592 Prepaid acquisition fees and expenses, net of accumulated amortization of $6,099,180 and $4,510,838 (Note B) 10,384,462 11,972,804 Prepaid participation servicing fees, net of accumulated amortization of $1,858,497 and $1,260,283 (Note B) 3,636,050 4,234,264 Interest receivable and other assets 2,111,153 2,264,687 Total assets $293,157,724 $298,296,715 LIABILITIES AND SHAREHOLDERS' EQUITY Deferred income on Additional Loans (Note B) $ 2,755,705 $ 1,582,054 Other liabilities 30,949 27,085 Total liabilities 2,786,654 1,609,139 Commitments (Notes D and I) Shareholders' equity (Notes A and F): Common stock, no par value; 25,000,000 Shares authorized; 18,371,477 Shares issued and outstanding 289,864,327 296,565,241 Unrealized gain on MBS (Notes B and E) 506,743 122,335 Total Shareholders' equity 290,371,070 296,687,576 Total liabilities and Shareholders' equity $293,157,724 $298,296,715 The accompanying notes are an integral part of the financial statements. F-5 KRUPP GOVERNMENT INCOME TRUST II STATEMENTS OF INCOME For the Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995 Revenues: Interest income - PIMs and PIMIs: Base interest $13,828,125 $13,952,237 $12,371,386 Additional Loan interest 2,147,468 1,521,980 1,473,597 Participation interest 1,769,701 767,747 422,195 Interest income - MBS 2,847,442 3,122,508 4,615,991 Interest income - other 697,819 512,459 1,149,519 Total revenues 21,290,555 19,876,931 20,032,688 Expenses: Asset management fee to an affiliate (Note G) 2,002,992 2,056,861 2,121,271 Expense reimbursements to affiliates (Note G) 446,357 391,260 484,718 Amortization of prepaid expenses, fees and organization costs 2,186,556 2,094,905 1,909,898 General and administrative 391,165 334,723 391,013 Loss on sale of MBS - - 1,379,074 Total expenses 5,027,070 4,877,749 6,285,974 Net income (Notes B and H) $16,263,485 $14,999,182 $13,746,714 Earnings per share $ .89 $ .82 $ .75 Weighted average shares outstanding 18,371,477 18,371,477 18,371,477 The accompanying notes are an integral part of the financial statements. F-7 KRUPP GOVERNMENT INCOME TRUST II STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the Years Ended December 31, 1997, 1996 and 1995 Total Retained Unrealized Shareholders' Common Stock Earnings Gain on MBS Equity Balance at December 31, 1994 $313,748,150 $ - $ - $ 313,748,150 Dividends (9,217,690) (13,746,714) - (22,964,404) Net income - 13,746,714 - 13,746,714 Change in unrealized gain on MBS - - 1,387,525 1,387,525 Balance at December 31, 1995 304,530,460 - 1,387,525 305,917,985 Dividends (7,965,219) (14,999,182) - (22,964,401) Net income - 14,999,182 - 14,999,182 Change in unrealized gain on MBS - - (1,265,190) (1,265,190) Balance at December 31, 1996 296,565,241 - 122,335 296,687,576 Dividends (Notes F and H) (6,700,914) (16,263,485) - (22,964,399) Net income (Note H) - 16,263,485 - 16,263,485 Change in unrealized gain on MBS - - 384,408 384,408 Balance at December 31, 1997 $289,864,327 $ - $ 506,743 $290,371,070 Shared issued and outstanding for each of the three years ended December 31, 1997 are 18,371,477 The accompanying notes are an integral part of the financial statements. F-9 KRUPP GOVERNMENT INCOME TRUST II STATEMENTS OF CASH FLOWS For the Year Ended December 31, 1997, 1996 and 1995 1997 1996 1995 Operating activities: Net income $16,263,485 $ 14,999,182 $ 13,746,714 Adjustments to reconcile net income to net cash provided by operating activities: Loss on sale of MBS - - 1,379,074 Premium amortization 113,094 169,589 232,104 Amortization of prepaid expenses, fees and organization costs 2,186,556 2,094,905 1,909,898 Changes in assets and liabilities: Decrease in interest receivable and other assets 153,534 33,162 253,750 Increase(decrease) in other liabilities 3,864 6,509 (967) Net cash provided by operating activities 18,720,533 17,303,347 17,520,573 Investing activities: Investment in PIMs - (5,824,611) (46,065,971) Investment in Additional Loans (465,000) - (6,600,000) Prepayment on Additional Loan 1,265,000 - - Proceeds from sale of MBS - - 39,885,582 Principal collections on MBS 4,775,477 7,427,029 8,404,511 Principal collections on PIMs 1,800,237 1,633,902 1,299,930 Acquisition of MBS - (591,600) - Increase in deferred income on Additional Loans 1,173,651 555,432 546,081 Net cash provided by (used for) investing activities 8,549,365 3,200,152 ( 2,529,867) Financing activity: Dividends (22,964,399) (22,964,401) (22,964,404) Net increase (decrease) in cash and cash equivalents 4,305,499 (2,460,902) (7,973,698) Cash and cash equivalents, beginning of period 9,214,592 11,675,494 19,649,192 Cash and cash equivalents, end of period $13,520,091 $ 9,214,592 $ 11,675,494 Supplemental disclosure of noncash investing activities: Reclassification of investments in a PIM and PIMI to an MBS $15,093,814 $ - $ - The accompanying notes are an integral part of the financial statements. F-11 KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS A. Organization Krupp Government Income Trust II (the "Trust") was formed on February 8, 1991 by filing a Declaration of Trust in The Commonwealth of Massachusetts. The Trust is authorized to sell and issue not more than 25,000,000 shares of beneficial interest (the "Shares"). Berkshire Mortgage Advisors Limited Partnership (the Advisor ) acquired 10,000 of such Shares for $200,000 and 18,315,158 Shares were sold for $365,686,058 net of purchase volume discounts of $617,102 under a public offering which commenced on September 11, 1991 and was completed on February 12, 1993. Under the Dividend Reinvestment Plan ("DRP"), 46,319 Shares were sold for $880,061. The Trust shall terminate on December 31, 2030, unless earlier terminated by the affirmative vote of holders of a majority of the outstanding Shares entitled to vote thereon. B. Significant Accounting Policies The Trust uses the following accounting policies for financial reporting purposes: MBS The Trust accounts for its MBS in accordance with the Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ( FAS 115"), under the classification of available-for-sale. The Trust carries its MBS at fair market value and reflects any unrealized gains (losses) as a separate component of Shareholders' Equity. The Trust amortizes purchase premiums or discounts over the life of the underlying mortgages using the effective interest method. PIMs and PIMIs The Trust accounts for its MBS portion of a PIM or PIMI investments in accordance with FAS 115, under the classification of held to maturity. The Trust carriesthese MBS at amortized cost. The Federal Housing Administration Participating Insured Mortgages and all Additional Loans are carried at amortized cost unless the Advisor of the Trust believes there is an impairment in value, in which case a valuation allowance is established in accordance with Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, and Financial AccountingStandard No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Base interest is recognized based on the stated rate of the Department of Housing and Urban Development ("HUD") insured mortgage (less the servicer's fee) or the stated coupon rate of the Federal National Mortgage Association ("FNMA") MBS. The Trust recognizes interest related to the participation features as earned and when it deems these amounts to be collectible. The Trust defers the recognition of Additional Loan interest payments as income to the extent these interest payments are from escrows established with the proceeds of the Additional Loan. When the properties underlying the PIMIs generate sufficient cash flow from operations to make the required interest payments under the Additional Loans, the Trust will commence amortizing the deferred interest payments into income over the remaining estimated term of the Additional Loan. F-12 KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS, Continued Continued B. Significant Accounting Policies, Continued Cash Equivalents The Trust includes all short-term investments with maturities of three months or less from the date of acquisition in cash and cash equivalents. The Trust invests its cash primarily in commercial paper and money market funds with a commercial bank and has not experienced any loss to date on its invested cash. Prepaid Expenses and Fees Prepaid expenses and fees represent prepaid acquisition fees and expenses and prepaid participation servicing fees paid for the acquisition and servicing of PIMs and PIMIs. The Trust amortizes prepaid acquisition fees and expenses using a method that approximates the effective interest method over a period of ten to twelve years, which represents the actual maturity or anticipated payoff date of the underlying mortgage. The prepaid participation servicing fees are amortized using a method that approximates the effective interest method over a ten year period beginning at final endorsement of the loan if a HUD-insured loan and at closing if a FNMA loan. Income Taxes The Trust has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and believes it will continue to meet all such qualifications. Accordingly, the Trust will not be subject to federal income taxes on amounts distributed to shareholders provided it distributes annually at least 95% of its REIT taxable income and meets certain other requirements for qualifying as a REIT. Therefore, no provision for federal income taxes has been recorded in the financial statements. Estimates and Assumptions The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, contingent assets and liabilities and revenues and expenses during the period. Significant estimates include the net carrying value of Additional Loans and the unrealized gain on MBS investments. Actual results could differ from those estimates. C. PIMIs The Trust has investments in eleven PIMIs that provide financing primarily for multi-family housing. Each PIMI consists of a FNMA MBS or a sole participation interest in a HUD-insured first mortgage loan originated under the FHA lending program (collectively, the "insured mortgages") and an "Additional Loan" made to the borrower or the owners of the borrower to provide additional funds for the construction or permanent financing of the property. The FHA first mortgage loan and the first mortgage underlying the FNMA MBS provide the borrower with a below market interest rate loan, and in return, the Trust receives a percentage of the cash generated from Continued C. PIMIs, Continued the property operations ( Participating Income Interest ) and a percentage of any appreciation of the underlying property to a preferred return, then a percentage of any appreciation thereafter ( Participating Appreciation Interest ) (collectively the Participation Interest ). The borrower conveys the participation features to the Trust through a subordinated promissory note and mortgage or a subordinate loan agreement (collectively the "Agreements"). The Trust makes the Additional Loan under the FNMA PIMIs directly to the borrower of the first mortgage loan underlying the FNMA MBS, and the borrower collateralizes the Additional Loan with a subordinated mortgage on the property. The owners of the borrower also pledge their ownership interests in the borrower as additional collateral. The Trust made the Additional Loans of the FHA PIMIs to the owners of the entity having the FHA first mortgage loan, and the owners collateralize the Additional Loan by pledging their ownership interests in the borrowing entity, their share of any distributions received, and the proceeds realized upon the refinancing of the property, sale of the property or sale of the partnership interests. Unlike the insured mortgages, the Additional Loans are neither guaranteed nor insured. The Trust receives monthly payments of principal and interest from the insured mortgages and is also entitled to receive Participation Interest and semi-annual interest payments ("Base Interest") and preferred interest under the Additional Loans and Agreements. While principal and interest payments on the insured mortgages are insured or guaranteed, there are limitations to the amount and obligation to pay interest under the Additional Loan and Agreements. The Additional Loan and Agreements for FNMA PIMIs entitles the Trust to receive (i) semi-annual payments of Base Interest on the Additional Loan, (ii) Participating Income Interest, (iii) Participating Appreciation Interest and (iv) Preferred Interest. Base Interest accrues at the stated interest rate of the Additional Loan and Participating Income Interest represents the Trust's share of the net revenue generated by the property at a stated percentage generally ranging from 25% to 35%. Base Interest and Participating Income Interest are payable only to the extent there is net revenue available to pay these amounts. However, should the borrower be unable to make the full Base Interest payment, the borrower must notify the Trust of the amount of the shortfall. The Trust can require the partners of the borrower to make a capital call contribution to the borrower to fund 50% of this shortfall, and the Trust will fund the remainder with an Operating Loan. Also, the Trust is generally limited to receiving no more than 50% of net revenue on any semi-annual payment date. Participating Appreciation Interest provides the Trust with a stated percentage, ranging from 25% to 30%, of the excess value of the property over amounts due under the first mortgage, Additional Loan and any Operating Loans, the repayment of capital call contributions, and a return of original equity to the partners of the borrower. Participating Appreciation Interest is due upon the sale, refinancing, maturity or accelerated maturity, or permitted prepayment of all amounts due under the insured mortgage and Additional Loan. Generally, the Trust will not receive more than 50% of the excess of value over the outstanding indebtedness, the payment of Preferred Interest, and the return of equity and capital call contributions to the partners of the borrower. Continued C. PIMIs, Continued Preferred interest refers to a non-compounded cumulative return from the closing date of the loan to the date of calculation, at a stated interest rate generally on the original outstanding balance of the insured mortgage plus the Additional Loan and any other funds advanced to the borrower (reduced by principal payments received) less: (i) interest payments on the insured mortgage, (ii) Base Interest payments on the Additional Loan, (iii) Participating Income Interest, and (iv) Participating Appreciation Interest. Generally, the amount of Preferred Interest owed cannot exceed the excess of value over the outstanding indebtedness. Amounts due under the Additional Loan and Agreements are neither insured nor guaranteed. The Agreements for FHA PIMIs entitle the Trust to receive (i) Participating Income Interest at a stated percentage usually ranging from 25% to 50% of (a) all distributable Surplus Cash generated by the property as defined in the regulatory agreement of the HUD-insured first mortgage loan, (b) unrestricted cash generated by property operations, and (c) unexpended reserves and escrows; and (ii) Participating Appreciation Interest at a stated percentage usually ranging from 20% to 50% of the proceeds or value of the property less the outstanding indebtedness upon the sale, refinancing, maturity or accelerated maturity, or permitted prepayment of all amounts due under the insured mortgage and Additional Loan. Amounts received by the Trust pursuant to this Agreement reduce amounts payable as Base Interest and Preferred Interest under the FHA PIMI Additional Loan. The FHA PIMI Additional Loan Base Interest is payable from the following sources: (i) any Surplus Cash received as Participating Income Interest, (ii) amounts conveyed to the Trust by the owners of the borrower representing distributions of Surplus Cash, and (iii) amounts in reserve accounts established with Additional Loan proceeds, if available, and any interest earned on these amounts. As with the FNMA PIMIs, the borrower must notify the Trust of the amount of any Base Interest shortfall. At its option the Trust can require the owners of the borrower to make a capital call for 50% of the shortfall and the Trust would forego the remainder. The FHA PIMIs also require the payment of Preferred Interest at a stated interest rate from the date of final endorsement to the date of calculation on the original outstanding balance of the insured mortgage plus the Additional Loan and any other funds advanced by the Trust to the borrower or owners of the borrowing entity (reduced by principal payments received) less: (i) interest payments paid to the Trust under the insured mortgage, (ii) Participating Income Interest, and (iii) Base Interest payments made under the Additional Loan including amounts foregone by the Trust. The insured mortgage and Agreements generally have maturities of 15 to 40 years, however, under the Agreements the Trust can accelerate the maturity dates at any time after the ninth or tenth anniversary of final endorsement for the FHA PIMIs or the closing date of the FNMA PIMIs, upon giving twelve months written notice for the payment. If the Trust accelerates the maturity date, the Trust can require payment of all amounts due under the Additional Loan and Agreements through the accelerated maturity date for the payment of amounts due under the Agreement and the HUD-insured first mortgage loan (providing the contract of insurance with the Secretary of HUD is canceled prior to the accelerated maturity date) or prepayment of the first mortgage loan underlying the FNMA MBS. Continued C. PIMIs, Continued FHA PIMIs generally cannot be prepaid for a term of five years from the construction completion date or final endorsement. After the fifth anniversary of construction completion or final endorsement, the FHA PIMI may be prepaid without penalty providing that all amounts due under the Agreements, Additional Loan and FHA insured mortgage are paid. FNMA PIMIs generally cannot be prepaid during the five years following the closing date of the underlying first mortgage loan. Thereafter, the FNMA first mortgage loan may be prepaid subject to a prepayment penalty that declines each year for the next five years with no prepayment penalty after the fifth year. Any prepayment of a FNMA PIMI generally requires prepayment of the first mortgage loan underlying the FNMA MBS and payment of amounts due under the Agreements and Additional Loan. The FNMA first mortgage loan would not need to be prepaid if there is a permitted assumption of the first mortgage loan, however, amounts due under the Agreement and Additional Loan would need to be prepaid. Any prepayment usually requires not less than 90 nor more than 180 days prior written notice. During the second quarter of 1997, the Trust advanced an additional $465,000 to the owner of the Willows Apartments, increasing the Additional Loan to $1,265,000. During the third quarter of 1997, as a result of a sale of the property to a third party, the Trust accepted a full repayment of the $1,265,000 Additional Loan and received all of its Preferred Interest of $789,336 that was earned as of the date of the sale. In conjunction with the repayment of the Additional Loan, the Trust converted the investment from a PIMI to an insured mortgage. At December 31, 1997 and 1996 there are no insured mortgage loans within the Trust s portfolio that are delinquent of principal or interest. The Trust's investments in PIMIs consists of the following at December 31, 1997 and 1996: F-17 KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS, Continued Continued C. PIMIs, Continued Insured Loan Interest Maturity Balance Outstanding Mortgages Amount Rate Date at December 31, 1997 1996 FHA The Seasons (a) $ 23,224,649 7.875% 10/1/28 $ 22,626,180 $ 22,788,436 Hunters Pointe 12,789,100 6.875% 1/1/35 12,600,517 12,669,542 Norumbega Point 15,598,500 7.375% 2/1/36 15,471,328 15,539,949 (b) (c) FNMA (d) Crossings Village 12,907,334 6.75% 10/1/08 12,403,728 12,542,615 Martin's Landing 11,200,000 6.5% 12/1/08 10,756,840 10,880,778 Sunset Summit 10,192,801 6.5% 10/1/08 9,796,408 9,909,281 Oasis 12,401,673 6.75% 9/1/09 12,040,522 12,164,562 Windsor Lake 9,680,344 6.75% 7/1/09 9,394,283 9,492,533 St. Germain 11,772,494 6.75% 1/1/09 11,127,209 11,322,292 The Willows 3,600,000 7.075% 12/1/09 - 3,540,322 Windmill Lakes 11,600,000 6.825% 3/1/10 11,313,766 11,425,179 The Lakes 18,387,653 6.825% 7/1/10 18,006,453 18,178,541 $153,354,548 $145,537,234 (h) $150,454,030 Base Preferred Interest Interest Additional Loan 1997 1996 Rate Rate The Seasons (a) $4,925,351 $ 4,925,351 9%(e) 10% Hunters Pointe 650,000 650,000 7% 9% Norumbega Pointe 3,063,000 3,063,000 7% 10% Crossings Village 2,584,000 2,584,000 7% 9% Martin s Landing 2,280,000 2,280,000 7% 12% Sunset Summit 1,900,000 1,900,000 7% 9%(f) St. Germain 2,860,000 2,860,000 7% Oasis 2,290,000 2,290,000 7% 9.25% Windsor Lake 2,000,000 2,000,000 8% 13% The Willows - 800,000 7% 9.5% Windmill Lakes(g) 2,000,000 2,000,000 7.5% 9.5% The Lakes 4,600,000 4,600,000 7% 9% $29,152,351 $29,952,351 Continued C. PIMIs, Continued (a) The total PIM and Additional Loan on this property are $32,300,000 and $6,850,000, respectively, of which 28% is held by Krupp Government Income Trust, an affiliate of the Advisor of the Trust. (b) The FHA approved an increase of the total loan commitment to $15,598,500. (c) The Trust received interest during the construction phase at a rate of 8.125% per annum. (d) Monthly principal and interest payments are based on a 30- year amortization with the exception of St. Germain which is based on a 25-year amortization. The unpaid principal balances due at maturity are as follows: Crossings Village $ 9,917,000 Martin's Landing $ 8,524,000 Sunset Summit $ 7,763,000 Oasis $ 9,550,000 Windsor Lake $ 7,517,000 St. Germain $ 7,489,000 Windmill Lakes $ 8,907,000 The Lakes $14,118,000 (e) The base interest rate was 6% per annum for the first three years and beginning September 1, 1996 increased to 9% per annum. (f) The Trust will receive its Base Interest Rate and its GIT Contingent Interest on Investment (as defined in the Subordinate Loan Agreement) from net revenue up to the 9% Preferred Interest Rate and, thereafter is entitled to 25% of net revenue. (g) As of December 31, 1997 Windmill Lakes was in technical default on its Additional Loan for not making the full required base interest payment due on the Additional Loan. The Advisor is reviewing the property s operating results to determine whether an operating loan may be required. (h) The aggregate cost for federal income tax purposes is $145,537,234. F-19 KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS, Continued Reconciliations of activity for 1997, 1996 and 1995 are as follows: 1997 1996 1995 Balance at beginning of period $150,454,030 $150,448,995 $116,047,812 Acquisitions - 1,303,436 35,427,771 Reclassification (3,515,288) - - Principal collections (1,401,508) (1,298,401) (1,026,588) Balance at end of period $145,537,234 $150,454,030 $150,448,995 Property Descriptions: The Seasons is a 1,088-unit apartment complex located in Laurel, Maryland. The Falls at Hunter's Pointe ("Hunter's Pointe") is a 276-unit apartment complex located in Sandy City, Utah, a suburb of Salt Lake City. Norumbega Point is a 93-unit assisted living facility in Weston, Massachusetts. Crossings Village Apartments ("Crossings Village") is a 286-unit apartment complex located in Westlake, Ohio. Continued F-20 KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS, Continued C.PIMIs, Continued Martin's Landing Apartments ("Martin's Landing") is a 300-unit apartment complex in Roswell, Georgia. Sunset Summit Apartments ("Sunset Summit") is a 261-unit apartment complex located in Portland, Oregon. Oasis at Springtree ("Oasis") is a 276-unit apartment complex located in Sunrise, Florida. Windsor Lake Apartments ("Windsor Lake") is a 416-unit apartment complex in Smyrna, Georgia. St. Germain Apartments ("St. Germain") is a 207-unit apartment complex in Boston, Massachusetts. The Willows Apartments ("The Willows") is a 100-unit apartment complex in Redmond, Washington. Windmill Lakes Apartments ("Windmill Lakes") is a 264-unit garden style apartment complex in Pembroke Pines, Broward County, Florida. The Lakes at Vinings Apartments ("The Lakes") is a 464-unit garden and townhouse style apartment complex in Vinings, Georgia. D. PIMs The Trust has investments in five PIMs. Currently four PIMs are for existing properties and one is funding the construction of multi-family housing. The Trust's PIMs consist of a FNMA MBS which represents the securitized first mortgage loan on the underlying property or a sole participation interest in the first mortgage loan originated under the FHA lending program on the underlying property (collectively the "insured mortgages") and participation interests in the revenue stream and appreciation of the property above specified levels. The borrower conveys these participation features to the Trust generally through a subordinated promissory note and mortgage (the "Agreement"). The Trust receives monthly principal and interest payments on the FNMA MBS guaranteed by FNMA, and HUD insures payment of principal and interest on the FHA first mortgage loan. Construction-phase PIMs provide interest only payments on the amount invested during construction, and upon final endorsement (final draw and completion of construction) these construction-phase PIMs convert to permanent PIMs. The borrower generally cannot prepay the first mortgage loan during the first five years and may prepay the first mortgage loan thereafter subject to a 9% prepayment penalty in years six through nine, a 1% prepayment penalty in year ten and no prepayment penalty thereafter. The Trust may receive interest related to its participation interests in the underlying property, however, these amounts are neither insured nor guaranteed. Generally, the participation features consist of the following: (i) "Minimum Additional Interest" at rates ranging from .5% to .75% per annum calculated on the unpaid principal balance of the first mortgage on the underlying property , (ii) "Shared Income Interest" ranging from 25% to 30% of the monthly gross rental income generated by the underlying property in excess of a specified base, but only to the extent that it exceeds the amount of Minimum Additional Interest received during such month, (iii) "Shared Appreciation Interest" ranging from 25% to 30% of any increase in value of the underlying property in excess of a specified base. Payment of participation interest from the operations of the property is limited to 50% of net revenue or surplus cash as defined by FNMA or HUD, respectively. The total amount of Participation interest payable by the underlying borrower generally cannot exceed 50% of any increase in value of the property, however, generally any net proceeds from a sale or refinancing will be available to satisfy any accrued but unpaid minimum additional or shared income interest. Shared Appreciation Interest is payable when one of the following occurs: (1) the sale of the underlying property to an unrelated third party on a date which is later than five years from the date of the Agreement, (2) the maturity date of the Agreement, or (3) prepayment of the Agreement. Under the Agreement, the Trust, upon giving twelve months written notice, can accelerate the maturity date of the Agreement and insured mortgage to a date not earlier than ten years from the date of the Agreement for(a) the payment of all Participation interest due under the Agreement as of the accelerated maturity date or (b) the payment of all Participation interest due under the Agreement plus all amounts due on the first mortgage note on the property. During the fourth quarter, the borrower on the Estates PIM sold the property to one of the Trust s affiliated entities. To facilitate the sale transaction, the borrower asked and the Advisor agreed to release the participation features of the PIM and allow the purchaser to assume the obligations of the first mortgage loan. In exchange for this modification, the Advisor required the borrower to pay a settlement of $232,000 to provide the Trust with a financial return comparable to what the Trust would have expected to receive had the borrower continued to own the property. In conjunction with this tranaction, the Trust converted the investment from a PIM to an insured mortgage. At December 31, 1997 and 1996, the Trust had outstanding commitments on its closed construction-phase PIMs of $1,006,000. The remaining commitment will be funded from cash and cash equivalents and MBS principal collections. At December 31, 1997 and 1996 there are no insured mortgage loans within the Trust s portfolio that are delinquent of principal or interest. The Trust's PIMs consisted of the following at December 31, 1997 and 1996: Interest Maturity PIM Amount Rate Date Balance at December31, 1997 1996 FNMA Mequon Trails $14,937,726 6.50% 1/01/08 $14,170,803 $14,355,629 (a) FHA The Estates 12,000,000 6.875% 6/01/28 - 11,692,400 Rivergreens II 6,137,199 7.375% 1/1/35 6,058,069 6,087,163 Mill Ponds II 8,245,300 7.125% 12/1/35 8,169,935 8,208,979 (c) The Fountains 10,336,000 7.875% 11/1/36 9,246,275 9,278,166 (d) Total $51,656,225 $37,645,082 $49,622,337 (e) F-24 KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS, Continued D.PIMs, Continued (a) Principal and interest payments are based on a 30-year amortization. Unpaid principal of approximately $11,267,000 is due at maturity. (b) Construction-phase interest rate was 8.875% per annum. Received Final Endorsement in August 1995. (c) Construction-phase interest rate was 7.125%. Received Final Endorsement in May 1996. (d) Construction-phase interest rate is 7.875%. (e) The aggregate cost for federal income tax purposes is $37,645,082. Reconciliations of activity for 1997, 1996 and 1995 are as follows: 1997 1996 1995 Balance at beginning of period $49,622,337 $45,436,663 $35,071,805 Acquisitions - 4,521,175 10,638,200 Reclassification (11,578,526) - - Principal collections (398,729) (335,501) (273,342) Balance at end of period $37,645,082 $49,622,337 $45,436,663 Property descriptions: Mequon Trails Townhomes ("Mequon Trails") is a 246-unit apartment complex located in Mequon, Wisconsin. The Estates Apartments is a 208-unit apartment complex located in Pikesville, Maryland. Rivergreens II Apartments ("Rivergreens II") is a 126-unit apartment complex in Gladstone, Oregon. Mill Ponds II Apartments ("Mill Ponds II")is a 150-unit apartment complex in Bellbrook, Ohio. The Fountains Apartments ("The Fountains") will be a 204-unit apartment complex in West Des Moines, Iowa. E. Mortgage Backed Securities At December 31, 1997, the Trust's MBS portfolio has an amortized cost of approximately $50,664,558 and gross unrealized gains and losses of approximately $547,435 and $40,692, respectively. At December 31, 1996, the Trust's MBS portfolio has an amortized cost of $40,459,315 and gross unrealized gains of approximately $122,335. The MBS have maturities ranging from 2008 to 2023. F. Shareholders' Equity Under the Declaration of Trust, and commencing with the initial closing of the public offering of Shares, the Trust has declared and paid dividends on a quarterly basis. During the period in which the Trust qualifies as a REIT, the Trust has and will pay quarterly dividends aggregating at least 95% of taxable income on an annual basis to be allocated to the shareholders, in proportion to their respective number of shares. F-26 NOTES TO FINANCIAL STATEMENTS, Continued F. Shareholders' Equity, continued In order for the Trust to maintain its REIT status with respect to the requirements of Share ownership, the Declaration of Trust prohibits any investor from owning, directly or indirectly more than 9.80% of the outstanding Shares and empowers the Trustees to refuse to permit any transfer of Shares which, in their opinion, would jeopardize the status of the Trust as a REIT. G. Related Party Transactions Under the terms of the Advisory Service Agreement, the Advisor receives an Asset Management Fee equal to .75% per annum of the value of the Trust's actual and committed invested assets payable quarterly. The Trust also reimburses affiliates of the Advisor for certain expenses incurred in connection with maintaining the books and records of the Trust and the preparation and mailing of financial reports, tax information and other communications to investors. The Trust earned or received $1,024,097, $295,522 and $295,522 of base interest from The Seasons in 1997, 1996 and 1995, respectively (see Note C). In addition, the Trust received $83,360 in 1997 related to participating interest income. H. Federal Income Taxes The reconciliation of the income reported in the accompanying statement of income with the income reported in the Trust's 1997 federal income tax return follows: Net income per statement of income $16,263,485 Add: Book to tax difference for amortization 966,743 of prepaid fees and expenses Additional Loan interest deferred for book purposes 1,073,578 Net income for federal income tax purposes $18,303,806 The Trust paid dividends of $1.25 per share during 1997 which represents approximately $1.00 from ordinary income and $.25 represents a non-taxable distribution for federal income tax purposes. The basis of the Trust s assets for financial reporting purposes is less than its tax basis by approximately $4,728,000 and $4,157,000 at December 31, 1997 and 1996, respectively. The basis of the Trust s liabilities for financial reporting purposes exceeded its tax basis by approximately $2,545,000 and $1,582,000 at December 31, 1997 and 1996, respectively I. Fair Value Disclosures of Financial Instruments The Trust uses the following methods and assumptions to estimate the fair value of each class of financial instrument: Cash and Cash Equivalents The carrying amount approximates fair value because of the short maturity of those instruments. MBS The Trust estimates the fair value of MBS based on quoted market prices. PIMs and PIMIs There is no established trading market for these investments. Management estimates the fair value of the PIMs and the insured mortgage portion of the PIMIs using quoted market prices of MBS having the same stated coupon rate as the insured mortgages and Additional Loans based on the estimated fair value of the underlying properties. Management does not include any participation income in the Trust s estimated fairvalues, because Management does not believe it can predict the time of realization of the feature with any certainty. Based on the estimated fair value determined using these methods and assumptions, the Trust's investments in PIMs and PIMIs had gross unrealized losses of approximately $3,804,000 at December 31, 1997 and gross unrealized losses and gains of approximately $8,932,000 and $119,000 at December 31, 1996. Commitments to Fund Construction Loans and PIMIs For the years ended December 31, 1997 and 1996 the Trust approximates the fair values of its commitments on closed PIMs to be equal to the commitment amount of approximately $1,006,000. At December 31, 1997 and 1996, the estimated fair values of the Trust's financial instruments are as follows: (rounded to thousands) 1997 1996 Cash and cash equivalents $ 13,520 $ 9,215 MBS 51,171 40,582 PIMs and PIMIs: PIMs 37,534 48,132 Insured mortgages 144,599 145,768 Additional loans 26,397 27,315 $273,221 $271,012 F-30 KRUPP GOVERNMENT INCOME TRUST II SUPPLEMENTARY DATA SELECTED QUARTERLY FINANCIAL DATA (Unaudited) For the Quarter Ended March 31, June 30, September 30, December 31, 1997 1997 1997 1997 Total revenues $5,306,978 $5,057,310 $6,072,765 $4,853,502 Net income $4,012,616 $3,822,465 $4,788,267 $3,640,137 Earnings per Share $ .22 $ .21 $ .26 $ .20 For the Quarter Ended March 31, June 30, September 30, December 31, 1996 1996 1996 1996 Total revenues $5,234,390 $4,884,080 $4,935,430 $4,823,031 Net income $3,975,003 $3,665,234 $3,706,177 $3,652,768 Earnings per Share $ .22 $ .20 $ .20 $ .20 F-32