DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP - Annual Report: 2006 (Form 10-K)

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FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark One)

For the fiscal year ended December 31, 2006

OR

For the transition period from              to             

Commission file number 0-17686

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

(Exact name of registrant as specified in its charter)

1100 Main Street, Suite 1830 Kansas City, Missouri 64105

(Address of principal executive offices, including zip code)

(816) 421-7444

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Limited Partnership Interests

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

Index to Exhibits located on page: 51-52

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PART I

Item 1. Business

Background

The Registrant, DiVall Insured Income Properties 2 Limited Partnership (the “Partnership”), is a limited partnership organized under the Wisconsin Uniform Limited Partnership Act pursuant to an Agreement of Limited Partnership dated as of November 18, 1987, and amended as of November 25, 1987, February 20, 1988, June 21, 1988, February 8, 1993, May 26, 1993 and June 30, 1994 (collectively, the “Partnership Agreement”). As of December 31, 2006, the Partnership consisted of one General Partner (“Management”) and 2,045 Limited Partners owning an aggregate of 46,280.3 Limited Partnership Interests (the “Interests”) acquired at a public offering price of $1,000 per Interest before volume discounts. The Interests were sold commencing February 23, 1988, pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933 (Registration 33-18794) as amended. On June 30, 1989, the former general partners exercised their option to extend the offering period to a date no later than February 22, 1990. On February 22, 1990, the Partnership closed the offering at 46,280.3 Interests ($46,280,300), providing net proceeds to the Partnership after volume discounts and offering costs of $39,358,468.

The Partnership is currently engaged in the business of owning and operating its investment portfolio of commercial real estate properties (the “Properties”.) The Properties are leased on a triple net basis to, and operated by, primarily franchisees of national, regional and local retail chains under long-term leases. The lessees are predominantly fast food, family style, and casual/theme restaurants, but also include a video rental store and a child-care center. At December 31, 2006, the Partnership owned 19 properties with specialty leasehold improvements in six (6) of these properties, as noted in Item 2- Properties. During the Second Quarters of 2001, 2003 and 2005, consent solicitations were circulated (the “2001, 2003 and 2005 Consents, respectively”), which if approved would have authorized the sale of the Partnership’s assets and dissolution of the Partnership. A majority of the Limited Partners did not vote in favor of either the 2001, 2003 or 2005 Consents. Therefore, the Partnership continued to operate as a going concern. The bi-annual consent solicitation is scheduled to be mailed in May of 2007, which if approved would authorize the sale of the Partnership’s assets and dissolution of the Partnership.

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

Since over 90% of the Partnership’s investment in properties involves restaurant tenants, the restaurant market is the major market segment with a material impact on Partnership operations. It would appear that the management skill and potential operating efficiencies realized by Partnership lessees will be a major ingredient for their future operating success in a very competitive restaurant and food service marketplace.

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

A preliminary investigation during 1992 by the Office of the Commissioner of Securities for the State of Wisconsin and the Securities and Exchange Commission (the “Investigation”), revealed that during at least the four years ended December 31, 1992, two of the former general partners of the Partnership, Gary J. DiVall (“DiVall”) and Paul E. Magnuson (“Magnuson”) had transferred substantial cash assets of the Partnership and two affiliated publicly registered limited partnerships, DiVall Insured Income Fund Limited Partnership (“DiVall 1”) and DiVall Income Properties 3 Limited Partnership (“DiVall 3”) (collectively the “Partnerships”) to various other entities previously sponsored by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers were in violation of the respective Partnership Agreements.

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

The Permanent Manager Agreement

The Permanent Management Agreement (“PMA”) was entered into on February 8, 1993, between the Partnership, DiVall 1 (which was dissolved in December 1998), DiVall 3 (which was dissolved in December 2003), the now former general partners DiVall and Magnuson, their controlled affiliates, and TPG, naming TPG as the Permanent Manager. The PMA contains provisions allowing the Permanent Manager to submit the PMA, the issue of electing the Permanent Manager as General Partner, and the issue of acceptance of the resignations of the former general partners to a vote of the Limited Partners through a solicitation of written consents.

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

The PMA had an original expiration date of December 31, 2002. At the end of the original term, it was extended three years by TPG to an expiration date of December 31, 2005. Effective January 1, 2006, the PMA was renewed by TPG for the three-year period ending December 31, 2008. The new expiration date could be terminated earlier (a) by a vote at any time by a majority in interest of the Limited Partners, (b) upon the

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dissolution and winding up of the Partnership, (c) upon the entry of an order of a court finding that the Permanent Manager has engaged in fraud or other like misconduct or has shown itself to be incompetent in carrying out its duties under the Partnership Agreement, or (d) upon sixty (60) days written notice from the Permanent Manager to the Limited Partners of the Partnership.

Advisory Board

The concept of the Advisory Board was first introduced by TPG during the solicitation of written consents seeking to elect TPG as the substitute general partner, and is the only type of oversight body known to exist for similar partnerships at this time. The first Advisory Board was appointed in October 1993, and held its first meeting in November 1993. Among other functions, the three person Advisory Board has the following rights: to review operational policies and practices; to review extraordinary transactions; to review internal financial controls and practices; and to review the performance of the independent auditors of the Partnership. The Advisory Board powers are advisory only and the Board does not have the authority to direct management decisions or policies of the Partnership or remove the General Partner. The Advisory Board has full and free access to the Partnership’s books and records, and individual Advisory Board members have the right to communicate directly with the Limited Partners concerning Partnership business. Members of the Advisory Board are compensated $1,500 annually and $500 for each quarterly meeting attended.

The Advisory Board currently consists of a broker dealer representative, William Arnold; and Limited Partners from the Partnership: Jesse Small and Albert Kramer. For a brief description of each Advisory Board member, refer to Item 10, Directors and Executive Officers of the Registrant.

The Partnership has no employees.

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

Item 1a. Risk Factors

General Risks Associated With Real Estate Ownership

The Partnership is subject to all of the general risks associated with the ownership of real estate. In particular, the Partnership faces the risk that rental revenue from its Properties may be insufficient to cover all operating expenses. Additional real estate ownership risks include:

upon the value of real estate;

applicable federal, state and local laws;

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Risks Related to Tenants

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

Since over 90% of the Partnership’s investment in properties involves restaurant tenants, the restaurant market is the major market segment with a material impact on Partnership operations. It would appear that the management skill and potential operating efficiencies realized by Partnership lessees will be a major ingredient for their future operating success in a very competitive restaurant and food service marketplace.

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

Illiquidity of Real Estate Investments

Because real estate investments are relatively illiquid, the Partnership is limited in its ability to quickly sell one or more Properties in response to changing economic, financial and investment conditions. The real estate market is affected by many forces, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond the Partnership’s control. There is no way to predict whether the Partnership will be able to sell any property for a price or on terms that would be acceptable to the Partnership. It is also impossible to predict the length of time needed to find a willing purchaser and to close the sale of a Property.

The Partnership May Be Subject to Unknown Environmental Liabilities

Investments in real property can create a potential for environmental liability. An owner of property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. The Partnership can face such liability regardless of the knowledge of the contamination; the timing or cause of the contamination; or the party responsible for the contamination of the property.

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The presence of hazardous substances on a property may adversely affect the Partnership’s ability to sell that property and it may incur substantial remediation costs. Although the Partnership leases generally require tenants to operate in compliance with all applicable federal, state and local environmental laws, ordinances and regulations, and to indemnify the Partnership against any environmental liabilities arising from the tenants’ activities on the property, the Partnership could nevertheless be subject to strict liability by virtue of its ownership interest. There also can be no assurance that tenants could or would satisfy their indemnification obligations under their leases. The discovery of environmental liabilities attached to the Partnership’s Properties could have an adverse effect on the Partnership’s results of operations, financial condition or ability to make distributions to limited partners.

Item 1b. Unresolved Staff Comments

None.

Item 2. Properties

Original lease terms for the majority of the investment properties were generally 5—20 years from their inception. All leases are triple-net which require the tenant to pay all property operating costs including maintenance, repairs, utilities, property taxes, and insurance. A majority of the leases contain percentage rent provisions, which require the tenant to pay a specified percentage (6% to 8%) of gross sales above a threshold amount.

The Partnership owned the following Properties (including specialty leasehold improvements for use in some of these properties and properties held for sale) as of December 31, 2006:

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Footnotes:

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are attached as Exhibit 99.1 to the Report of which these Financial Statements are a part. Such audited financial statements were prepared on behalf of Wencoast and may be considered relevant to an investor because Wencoast leases more than 20% of the Partnership’s properties, both by number and asset value.

The following summarizes significant developments, by property, for properties with such developments.

Sunrise Preschool- Phoenix, AZ Property

A listing agreement for the sale of the property was executed in June 2006. In early January of 2007, a sales contract was executed for the sale of the property for $1.6 million. Per notice from the Partnership, tenant, Borg Holdings, Inc. (“Borg”), had 30 days from January 16, 2007, to act upon their right of first refusal to purchase the Phoenix property, since a separate buyer entered into a real estate contract for the purchase of the property. On January 29, 2007, Borg informed the Partnership that they would be exercising their right to accept the terms of the contract for the sale of the Phoenix, AZ property. Closing is anticipated to be during the summer of 2007 and commissions totaling 6%, which includes 2% to a General Partner affiliate, are expected to be paid. The net book value of the property at December 31, 2006, classified as property held for sale, was approximately $617,000, which included $241,000 related to land, $386,000 related to buildings and improvements, and $10,000 related to security deposits.

Ogden, UT property

The Blockbuster lease on the current 6,000 square foot space expired on January 31, 2006. During lease renewal negotiations with Management, the tenant maintained possession of the property and paid the Partnership holdover rent for February and March 2006. In April of 2006, Management executed a two-year renewal lease agreement with the tenant, retroactive to February 1, 2006. The first base year rent will total $108,000. Leasing commissions related to the lease renewal execution totaled approximately $13,000, ($6,500 paid to a non-affiliated broker and $6,500 paid to a General Partner affiliate).

Grand Forks, ND Property

On January 24, 2006, the owners of the Panda Buffet Restaurant in Grand Forks, ND gave notice to Management that they intended to exercise their purchase option in relation to the property. A sales contract was executed on February 27, 2006 for the sale of the Grand Forks, ND property at a sales price of $525,000. Although closing was anticipated to be in the First Quarter of 2006, the sale was not consummated and the sales contract expired in late March of 2006. The original lease, which is set to expire in 2013, remains effective and includes the tenant’s option to purchase the property.

Popeye’s- Park Forest, IL

As of December 31, 2006, Popeye’s is delinquent on its April and May 2006 rent obligations and property taxes escrow payments totaling approximately $13,000 and $10,000, respectively. These unpaid amounts are accrued for at December 31, 2006. As of December 31, 2006, the tenant has a property tax escrow cash balance held with the Partnership of approximately $12,000. The Partnership received the required June through December 2006 rent and property taxes escrow payments.

In the Second Quarter of 2006, Management defaulted Popeye’s for failure to meet its lease obligations, and filed for possession of the Park Forest property in the Cook County Judicial Court. The Partnership continues the pursuit of all legal remedies available to recover possession and terminate the Lease. Popeye’s remains responsible for monthly rent obligations and property taxes through the remainder of its Lease (expires December 31, 2009).

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A Release and Settlement Agreement was executed with Popeye’s in November 2004. In settlement of all claims and disputes the following significant items were agreed to: (i) Popeye’s is to make monthly escrow property taxes payments applicable to 2004 and for future property taxes installments due throughout the remaining lease term obligation; (ii) Popeye’s gross sales breakpoint was increased to $1,000,000 and therefore, percentage rent shall be an amount equal to 8% of gross sales in excess of $1,000,000, and (iii) Popeye’s delinquent percentage rents were waived.

During 2004, property taxes escrow charges applicable to 2004 property taxes were reflected in the financial statements as escrow payments were actually received, and were recorded as a reversal of 2004 property taxes expense equal to the amount of payment received. The Partnership recognized property taxes recovery income of approximately $129,000 during 2004, which related to Popeye’s reimbursement to the Partnership of defaulted property taxes and penalties that had been previously expensed and paid by the Partnership. During 2005, property taxes escrow charges applicable to property taxes previously accrued and expensed in 2004, were reflected in the financial statements as escrow payments were actually received, and were recorded as property taxes recovery income equal to the amount of payment received. Property taxes recovery income during 2005 totaled approximately $35,000. Due to Popeye’s full reimbursement to the Partnership for past property taxes paid on the tenant’s behalf, and Popeye’s agreement to meet billing and escrow obligations, the 2005 and 2006 estimated property taxes were not expensed and accrued as of December 31, 2005 and 2006, respectively.

4785 Merle Hay Road- Des Moines, IA

In September 2005, the Partnership paid Daytona’s- All Sports Cafés (“Daytona’s”) first installment of its 2004 property taxes, which amounted to approximately $10,000. Daytona’s reimbursed the Partnership in the Fourth Quarter of 2005. Beginning in December 2005, Management requested that Daytona’s escrow its future property taxes liabilities with the Partnership on a monthly basis. Daytona’s remains current on its property tax escrow obligations. As of December 31, 2006, escrow payments held by the Partnership totaled approximately $18,000.

Former Miami Subs- Palm Beach, FL Property

The Palm Beach, FL property was sold in June 2004. At the time of closing the former tenant, DiFede Finance Group (“DiFede”), was delinquent $17,000 in past rent (after the application of a $15,000 security deposit). The former tenant also owed the Partnership approximately $13,360 in property taxes as the Partnership paid the property’s delinquent 2003 property taxes in June 2004. Management continued to pursue legal remedies to collect the former tenant’s total past due balances. Due to the uncertainty of collection, fifty percent (50 %) of the total outstanding receivable balance was reserved in June 2004.

In November 2004, a Settlement Agreement (“DiFede Agreement”) was executed with DiFede. Per the DiFede Agreement the former tenant agreed to pay the Partnership by December 31, 2004 approximately $36,000 in past due rent, late charges, related attorney and court fees and other miscellaneous items. However, the settlement payment per the DiFede Agreement was not received by the Partnership. Further legal action was taken by the Partnership and the Circuit Court in Broward County, Florida entered a final judgment (the “Judgment”) against DiFede in early January 2005, awarding approximately $42,000 in damages to the Partnership. Due to the uncertainty of collection, the remaining fifty percent (50 %) of the total outstanding receivable balance was written-off. The receivable balance and applicable allowance were removed from the balance sheet at December 31, 2004. Throughout 2005, Management continued their pursuit of legal action to collect the Judgment. In satisfaction of the Judgment (which was recorded in the Circuit Court in March 2006), the Partnership received $25,000 from Difede in the First Quarter of 2006.

Former Hooter’s- Richland Hills, TX

A sales contract was executed in October 2005 for the sale of the property in the Fourth Quarter of 2005 at a sales price of $1,575,000. The closing date on the sale of the property was December 2005 and the net sales

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proceeds totaled approximately $1,505,000. A net gain on the sale of $668,000 was recognized in the Fourth Quarter of 2005. Closing and other sale related costs amounted to $70,000, which included a sales commission paid to a General Partner affiliate totaling $47,250.

Former Twin Falls, ID property

In August 2004, the Partnership sold a piece of land adjacent to the former Twin Falls property for $5,000. The land had no recorded value.

Item 3. Legal Proceedings

Phoenix Foods Preference Claim

The trustee in the Phoenix Foods bankruptcy made a claim seeking to recover from the Partnership alleged “preferential payments” by Phoenix Foods to the Partnership in the amount of approximately $16,500. The payments the trustee sought to recover were rent payments received in the ordinary course of business prior to Phoenix Food’s bankruptcy. The Partnership did not believe such payments were preferential under the Bankruptcy Code and vigorously contested such characterization. A verbal settlement of this claim was reached in November 2004 and the Partnership finalized such settlement in April 2005. The settlement called for the bankruptcy trustee to release its preference claims and the Partnership to release its claims as an unsecured creditor in the Phoenix Foods bankruptcy. Although the Partnership believes its claims are valid, the Partnership determined that the time and cost of pursuing such claims exceeded the likely recovery given the bankrupt’s lack of assets from which to satisfy unsecured claims.

Former South Milwaukee, WI property

The Partnership sold real property and improvements located at 106 N. Chicago Avenue, South Milwaukee, Wisconsin to F2BL, LLC (the “Buyer”) on April 17, 2003 pursuant to a Real Estate Purchase Agreement dated October 10, 2002 (the “Contract”). In October of 2003, the Buyer notified the Partnership that an underground storage tank (“UST”) and petroleum release had been discovered on this Property. Since that time, the Buyer removed the UST and remediated the petroleum release. A substantial amount of the costs incurred in such efforts were paid by the Wisconsin Petroleum Environmental Clean Up Fund (the “PECUF”). In sporadic correspondence since the Fourth Quarter of 2003, the Buyer claimed, and the Partnership denied, that the Partnership was responsible for payment of those costs not reimbursed by the PECUF.

On January 23, 2006, the Buyer initiated a lawsuit against the Partnership by filing a Complaint with the Milwaukee County Circuit Court. The Complaint alleged, among other things that (i) the Partnership breached its representation in the Contract that, to the best of the Partnership’s knowledge, the Partnership was in compliance with all environmental laws, and (ii) the Partnership failed to deliver to Buyer a Phase I Environmental Assessment of the Property which had been performed in 1998. The Buyer sought a judgment awarding it damages to be proven at trial, plus its attorneys’ fees. Prior to filing suit, the Buyer alleged approximately $100,000 of actual unreimbursed damages incurred in the removal of the UST and remediation of the petroleum release and alleged consequential damages of $190,000. The Court set certain deadlines which included the completion of discovery and the filing of dispositive motions by February 20, 2007.

In September of 2006, Management and the Buyer entered into a Mutual Release of All Claims Agreement (“F2BL Agreement”). It is understood and agreed that the F2BL Agreement is a compromise of a doubtful and disputed claim, and that liability is expressly denied by the parties released. Pursuant to this F2BL Agreement the Partnership paid the Buyer $25,000 in settlement costs. Management believes that it had meritorious defenses to all of the Buyer’s claims and did not believe that a material recovery by the Buyer was probable. However, the Partnership determined that the time and cost to vigorously defend such litigation would exceed the settlement cost achieved.

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DeDan bankruptcy

During January 2004, the Partnership received a one-time payment of approximately $25,000 from the Bankruptcy Court in relation to bankruptcy litigation. In the late 1980’s, the Partnership leased properties to DeDan, Inc., and the leases were guaranteed by Dan Fore, the owner of DeDan, Inc. These leases went into default in the early 1990’s and the Partnership obtained possession of the properties and re-leased them to various entities. The original lessee, DeDan, Inc. and Dan Fore, filed for bankruptcy and the Partnership filed a claim in the Bankruptcy Court for damages incurred due to the lease defaults. The payment received was the result of extended litigation in the Bankruptcy Court. No additional payments are anticipated.

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

None.

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PART II

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

Item 6. Selected Financial Data

The Partnership’s selected financial data included below has been derived from the Partnership’s financial statements. The financial data selected below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and with the financial statements and the related notes appearing elsewhere in this annual report.

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

(A Wisconsin limited partnership)

As of and for the years ended

December 31, 2006, 2005, 2004, 2003, and 2002

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources:

Investment Properties and Net Investment in Direct Financing Leases

The Properties held by the Partnership at December 31, 2006 (does not include properties held for sale) were originally purchased at a price, including acquisition costs, of approximately $13,468,131.

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

As of December 31, 2006, the Partnership owned properties containing 17 fully constructed fast-food restaurants, a video store, and a preschool (all of which are owned and operated by entities unaffiliated with the Partnership). The 19 properties are composed of the following: ten (10) Wendy’s restaurants, one (1) Denny’s restaurant, one (1) Applebee’s restaurant, one (1) Popeye’s Famous Fried Chicken restaurant, one (1) Kentucky Fried Chicken restaurant, one (1) Chinese Super Buffet restaurant, one (1) Panda Buffet restaurant, one (1) Daytona’s- All Sports Café, one (1) Blockbuster Video store, and one (1) Sunrise Preschool (classified as property held for sale in June of 2006). The 19 properties are located in a total of nine (9) states.

Ten (10) of the nineteen (19) properties are leased to Wencoast Restaurants, Inc. (“Wencoast”). Since more than 20% of the Partnership’s properties, both by asset value and number, are leased to a single tenant, the financial status of the tenant may be considered relevant to investors. At the request of the Partnership, Wencoast provided it with copies of Wencoast’s most recent available audited financial statements for the periods ended January 2, 2005 and January 1, 2006. Those audited financial statements are attached to the December 31, 2006 Annual Report 10-K as Exhibit 99.1. These financial statements were prepared by Wencoast’s auditors. The Partnership has no rights to audit Wencoast and no right to dictate the form of the audited financials provided by Wencoast. The Partnership’s auditors have not audited the financial statements received from Wencoast. The Partnership has no reason to believe the Wencoast financial statements do not accurately reflect the financial position of Wencoast.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” current and historical results from operations for disposed properties and assets classified as held for sale that occur subsequent to January 1, 2002 are reclassified separately as discontinued operations.

During 2006, 2005 and 2004, the Partnership recognized income from discontinued operations of approximately $112,000, $921,000, and $495,000, respectively. The 2006 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property to property held for sale in the Second Quarter of 2006. The 2005 and 2004 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property to property held for sale in the Second Quarter of 2006 and the sale of the Hooters’s- Richland Hills, TX property in December of 2005. The 2004 income from discontinued operations also includes the sale of the Miami Subs- Palm Beach, FL property in June of 2004. The 2005 income from discontinued operations included a Fourth Quarter net gain on the sale of the Hooter’s restaurant property of approximately $668,000. The 2004 income from discontinued operations included a Second Quarter net gain on the sale of the Miami Subs property of approximately $211,000, a Third Quarter net gain on the sale of a parcel of land located adjacent to the former vacant Twin Falls, ID property of $5,000 (the land had no recorded value), and Second and Fourth Quarter provisions for non-collectible rents and other receivables related to the Miami Subs property.

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The components of property held for sale in the condensed balance sheets as of December 31, 2006 and 2005 are outlined below.

The components of discontinued operations included in the statements of income for the years ended December 31, 2006, 2005 and 2004 are outlined below.

The following summarizes significant developments, by property, for properties with such developments.

Sunrise Preschool- Phoenix, AZ Property

A listing agreement for the sale of the property was executed in June 2006. In early January 2007, a sales contract was executed for the sale of the property for $1.6 million. Per notice from the Partnership, tenant, Borg Holdings, Inc. (“Borg”), had 30 days from January 16, 2007, to act upon their right of first refusal to purchase the Phoenix property, since a separate buyer entered into a real estate contract for the purchase of the property. On January 29, 2007, Borg informed the Partnership that they would be exercising their right to accept the terms of the contract for the sale of the Phoenix , AZ property. Closing is anticipated to be during the summer of 2007 and commissions totaling 6%, which includes 2% to a General Partner affiliate, are expected to be paid. The net book value of the property at December 31, 2006, classified as property held for sale, was approximately $617,000, which included $241,000 related to land, $386,000 related to buildings and improvements, and $10,000 related to security deposits.

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Ogden, UT property

The Blockbuster lease on the current 6,000 square foot space expired on January 31, 2006. During lease renewal negotiations with Management, the tenant maintained possession of the property and paid the Partnership holdover rent for February and March 2006. In April 2006, Management executed a two-year renewal lease agreement with the tenant, retroactive to February 1, 2006. The first base year rent will total $108,000. Leasing commissions related to the lease renewal execution totaled approximately $13,000, ($6,500 paid to a non-affiliated broker and $6,500 paid to a General Partner affiliate).

Grand Forks, ND Property

On January 24, 2006, the owners of the Panda Buffet Restaurant in Grand Forks, ND gave notice to Management that they intended to exercise their purchase option in relation to the property. A sales contract was executed on February 27, 2006 for the sale of the Grand Forks, ND property at a sales price of $525,000. Although closing was anticipated to be in the First Quarter of 2006, the sale was not consummated and the sales contract expired in late March 2006. The original lease, which is set to expire in 2013, remains effective and includes the tenant’s option to purchase the property.

Popeye’s- Park Forest, IL

As of December 31, 2006, Popeye’s is delinquent on its April and May 2006 rent obligations and property taxes escrow payments totaling approximately $13,000 and $10,000, respectively. These unpaid amounts are accrued for at December 31, 2006. As of December 31, 2006, the tenant has a property tax escrow cash balance held with the Partnership of approximately $12,000. The Partnership received the required June through December 2006 rent and property taxes escrow payments.

In the Second Quarter of 2006, Management defaulted Popeye’s for failure to meet its lease obligations, and filed for possession of the Park Forest property in the Cook County Judicial Court. The Partnership continues the pursuit of all legal remedies available to recover possession and terminate the Lease. Popeye’s remains responsible for monthly rent obligations and property taxes through the remainder of its Lease (expires December 31, 2009).

A Release and Settlement Agreement was executed with Popeye’s in November 2004. In settlement of all claims and disputes the following significant items were agreed to: (i) Popeye’s is to make monthly escrow property taxes payments applicable to 2004 and for future property taxes installments due throughout the remaining lease term obligation; (ii) Popeye’s gross sales breakpoint was increased to $1,000,000 and therefore, percentage rent shall be an amount equal to 8% of gross sales in excess of $1,000,000, and (iii) Popeye’s delinquent percentage rents were waived.

During 2004, property taxes escrow charges applicable to 2004 property taxes were reflected in the financial statements as escrow payments were actually received, and were recorded as a reversal of 2004 property taxes expense equal to the amount of payment received. The Partnership recognized property taxes recovery income of approximately $129,000 during 2004, which related to Popeye’s reimbursement to the Partnership of defaulted property taxes and penalties that had been previously expensed and paid by the Partnership. During 2005, property taxes escrow charges applicable to property taxes previously accrued and expensed in 2004, were reflected in the financial statements as escrow payments were actually received, and were recorded as property taxes recovery income equal to the amount of payment received. Property taxes recovery income during 2005 totaled approximately $35,000. Due to Popeye’s full reimbursement to the Partnership for past property taxes paid on the tenant’s behalf, and Popeye’s agreement to meet billing and escrow obligations, the 2005 and 2006 estimated property taxes were not expensed and accrued as of December 31, 2005 and 2006, respectively.

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4785 Merle Hay Road- Des Moines, IA

In September 2005, the Partnership paid Daytona’s- All Sports Cafés (“Daytona’s”) first installment of its 2004 property taxes, which amounted to approximately $10,000. Daytona’s reimbursed the Partnership in the Fourth Quarter of 2005. Beginning in December 2005, Management requested that Daytona’s escrow its future property taxes liabilities with the Partnership on a monthly basis. Daytona’s remains current on its property tax escrow obligations. As of December 31, 2006, escrow payments held by the Partnership totaled approximately $18,000.

Former Miami Subs- Palm Beach, FL Property

The Palm Beach, FL property was sold in June 2004. At the time of closing the former tenant, DiFede Finance Group (“DiFede”), was delinquent $17,000 in past rent (after the application of a $15,000 security deposit). The former tenant also owed the Partnership approximately $13,360 in property taxes as the Partnership paid the property’s delinquent 2003 property taxes in June 2004. Management continued to pursue legal remedies to collect the former tenant’s total past due balances. Due to the uncertainty of collection, fifty percent (50 %) of the total outstanding receivable balance was reserved in June 2004.

In November 2004, a Settlement Agreement (“DiFede Agreement”) was executed with DiFede. Per the DiFede Agreement the former tenant agreed to pay the Partnership by December 31, 2004 approximately $36,000 in past due rent, late charges, related attorney and court fees and other miscellaneous items. However, the settlement payment per the DiFede Agreement was not received by the Partnership. Further legal action was taken by the Partnership and the Circuit Court in Broward County, Florida entered a final judgment (the “Judgment”) against DiFede in early January 2005, awarding approximately $42,000 in damages to the Partnership. Due to the uncertainty of collection, the remaining fifty percent (50 %) of the total outstanding receivable balance was written-off. The receivable balance and applicable allowance were removed from the balance sheet at December 31, 2004. Throughout 2005, Management continued their pursuit of legal action to collect the Judgment. In satisfaction of the Judgment (which was recorded in the Circuit Court in March 2006), the Partnership received $25,000 from Difede in the First Quarter of 2006.

Former Hooter’s- Richland Hills, TX

A sales contract was executed in October 2005 for the sale of the property in the Fourth Quarter of 2005 at a sales price of $1,575,000. The closing date on the sale of the property was December 2005 and the net sales proceeds totaled approximately $1,505,000. A net gain on the sale of $668,000 was recognized in the Fourth Quarter of 2005. Closing and other sale related costs amounted to $70,000, which included a sales commission paid to a General Partner affiliate totaling $47,250.

Former Twin Falls, ID property

In August 2004, the Partnership sold a piece of land adjacent to the former Twin Falls property for $5,000. The land had no recorded value.

Other Investment in Properties Information

According to the Partnership Agreement, the former general partners were to commit 80% of the original offering proceeds to investment in properties. Upon the close of the offering, approximately 75% of the original proceeds were invested in the Partnership’s properties.

At December 31, 2005, the tenant of the Panda Buffet property had an option to purchase the property at a price, which (i) exceeded the original cost of the property less accumulated depreciation and (ii) was not less than the fair market value of the property at the time the option was granted. On January 24, 2006, the owners of the Panda Buffet Restaurant in Grand Forks, ND gave notice to Management that they intended to exercise their

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purchase option in relation to the property, but the proposed sale was not consummated. (For further discussion see “Grand Forks, ND Property” above and in Note 3 to the condensed financial statements.) The original lease, which is set to expire in 2013, remains effective and includes the tenant’s option to purchase the property. The General Partner is not aware of any unfavorable purchase options in relation to the original cost or fair market value of the property at the time the option was granted, contained in any of the Partnership’s existing leases.

Other Assets

Cash and cash equivalents held by the Partnership totaled approximately $626,000 at December 31, 2006, compared to $2,219,000 at December 31, 2005. Cash of $370,000 is anticipated to be used to fund the Fourth Quarter 2006 distributions to Limited Partners in February 2007, and cash of $89,000 is anticipated to be used for the payment of year-end accounts payable and accrued expenses, and the remainder represents amounts deemed necessary to allow the Partnership to operate normally.

Cash generated through the operations of the Partnership’s Properties and sales of Properties will provide the sources for future fund liquidity and Limited Partner distributions.

Property held for sale at December 31, 2006 amounted to approximately $617,000 and related to the Sunrise Preschool property in Phoenix, AZ. A listing for the sale of the property was executed in June of 2006. In January of 2007, a sales contract was executed for the sale of the property for $1.6 million. Closing is anticipated to be during the summer of 2007. The property held for sale amount includes $241,000 related to land, $386,000 related to buildings and improvements, and $10,000 related to security deposits. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.)

Property tax cash escrow amounted to approximately $30,000 and $17,000 at December 31, 2006 and 2005, respectively. Daytona’s property tax cash escrow balance as of December 31, 2005 was approximately $3,000 and payments of approximately $35,000 were received by the Partnership from Daytona’s in 2006. The Partnership paid the tenant’s 2004 second property taxes installment of approximately $10,000 in the First Quarter of 2006 and the first property taxes installment for 2005 of approximately $11,000 in the Third Quarter of 2006. Daytona’s property tax cash escrow balance held by the Partnership as of December 31, 2006 was approximately $18,000. Daytona’s second property taxes installment for 2005 is scheduled to be due in the First Quarter of 2007. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.) Popeye’s property tax escrow cash balance as of December 31, 2005 was approximately $14,000 and payments of approximately $52,000 were received by the Partnership from Popeye’s in 2006. The Partnership paid the tenant’s first property taxes installment for 2005 of approximately $25,000 in the First Quarter of 2006 and the tenant’s second property taxes installment for 2005 of approximately $29,000 in the Third Quarter of 2006. Popeye’s property tax cash escrow balance held with the Partnership as of December 31, 2006 was approximately $12,000. Popeye’s first property taxes installment for 2006 is scheduled to be due in the First Quarter of 2007. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.)

The Partnership established an Indemnification Trust (the “Trust”) during the Fourth Quarter of 1993, deposited $100,000 in the Trust during 1993 and completed funding of the Trust with $150,000 during 1994. The provision to establish the Trust was included in the Permanent Manager Agreement for the indemnification of TPG, in the absence of fraud or gross negligence, from any claims or liabilities that may arise from TPG acting as Permanent Manager. The Trust is owned by the Partnership. (For additional information regarding the Trust refer to Note 8 to Financial Statements- PMA Indemnification Trust.)

Rents and other receivables amounted to $432,000 at December 31, 2006, compared to $431,000 as of December 31, 2005. As of December 31, 2006, Popeye’s- Park Forest was delinquent on two monthly lease obligations totaling approximately $13,000. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.) At December 31, 2006, rents and other receivables also included

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$417,000 in percentage rents accrued during 2006 for tenants who had reached their individual sales breakpoints. These percentage rents included $18,000 which were billed to tenant’s in the Fourth Quarter of 2006 and $399,000 which will not be billed to or owed by the tenant’s until the First Quarter of 2007. The December 31, 2005 rents and other receivables balance primarily represented unbilled 2005 quarterly percentage rent accruals. The 2005 percentage rents were billed in the First Quarter of 2006 and were fully collected as of June 30, 2006.

Property taxes receivable at December 31, 2006 totaled approximately $11,000. The balance primarily represented property taxes escrow charges due from Popeye’s – Park Forest applicable to its 2006 property taxes due in 2007. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.)

Prepaid Insurance amounted to approximately $32,000 at December 31, 2006 and $33,000 at December 31, 2005, which represented approximately ten months of prepaid insurance paid by the Partnership.

Deferred charges totaled approximately $244,000 and $247,000, net of accumulated amortization, at December 31, 2006 and December 31, 2005, respectively. Deferred charges represent leasing commissions paid when properties are leased or upon the negotiated extension of a lease. Leasing commissions of approximately $13,000 were accrued at March 31, 2006 and paid in April of 2006, due to the Blockbuster two-year lease renewal. (For further disclosure see Investment Properties- Ogden, UT property in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.) Leasing commissions are capitalized and amortized over the life of the lease.

Liabilities

Accounts payable and accrued expenses at December 31, 2006, and December 31, 2005 amounted to approximately $89,000 and $59,000, respectively, and primarily represented the year-end accruals of auditing, tax and data processing fees.

Property taxes payable at December 31, 2006, amounted to approximately $41,000. The balances primarily represented Popeye’s- Park Forest’s and Daytona’s property taxes escrow charges related to the tenant’s property taxes which are scheduled to be due in 2007. Property taxes payable at December 31, 2005, in the amount of $24,000, primarily represented 2005 property escrow charges for the Popeye’s- Park Forest property related to it first installment of 2006 property taxes which were paid in 2006. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.)

The amounts “Due to” the Current General Partner were $2,380 at December 31, 2006, and primarily represented the General Partner’s portion of the Fourth Quarter 2006 distribution.

Partners’ Capital

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

Cash distributions paid to the Limited Partners and to the General Partner during 2006 of $3,100,000 and $4,973, respectively, have also been made in accordance with the Partnership Agreement. The Fourth Quarter 2006 Limited Partner distributions totaling $370,000 were paid February 15, 2007.

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Results of Operations

The Partnership reported income from continuing operations for the year ended December 31, 2006, in the amount of $1,132,000 compared to income from continuing operations for the years ended December 31, 2005 and 2004 of $1,200,000 and $1,298,000, respectively. The variance in income from continuing operations in 2006 compared to 2005 and 2004 is due primarily to: (i) an unexpected insurance premium adjustment payment in the Second Quarter of 2006 of approximately $12,000 related to the 04/05 policy year, and Second through Fourth Quarter of 2006 accruals totaling $14,000 for estimated insurance premium adjustments related to the 05/06 and 06/07 policy years; (ii) higher income tax expenditures in the First through Third Quarters of 2006 related to the 2005 South Carolina tax return and the 2006 South Carolina estimated tax payments; (iii) higher professional service fees during 2006, such as data processing; (iv) a settlement payment of $25,000 paid in the Third Quarter of 2006 to the Buyer of the former South Milwaukee property (For further discussion see Legal Proceedings in Note 10 to Financial Statements and Part I- Item 3.); (v) the First through Third Quarter of 2005 total collections and revenue recognition of approximately $35,000 in property tax recoveries from Popeye’s (see Note 3- Investment Properties for further discussion) and (vi) a Third Quarter 2005 income tax liability accrual, payable to the City of Columbus, Ohio for the tax years 1999 through 2004. (vii) the Second through Fourth Quarter of 2004 collections and revenue recognition of $129,000 in property tax recoveries from Popeye’s (see Note 3- Investment Properties for further discussion; (viii) higher 2004 operating percentage rent accruals compared to 2005 and 2006; (ix) increased general and administrative expenditures related to investor communication, and increased professional expenditures, due to the 2005 Consent mailing in the Second Quarter of 2005; and (x) the March 2004 payment of Popeye’s 2001 property taxes second installment and related penalties due to tenant default.

Discontinued Operations

Income from discontinued operations was approximately $112,000, $921,000 and $495,000 for the years ended December 31, 2006, 2005, and 2004, respectively. In accordance with SFAS 144, discontinued operations represent the operations of properties disposed of or classified as held for sale subsequent to January 1, 2002 as well as any gain or loss recognized in their disposition. The 2006 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property to property held for sale in the Second Quarter of 2006. The 2005 and 2004 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property to property held for sale in the Second Quarter of 2006 and the sale of the Hooters’s- Richland Hills, TX property in December of 2005. The 2004 income from discontinued operations also includes the sale of the Miami Subs- Palm Beach, FL property in June of 2004. The 2005 income from discontinued operations included a Fourth Quarter net gain on the sale of the Hooter’s restaurant property of approximately $668,000. The 2004 income from discontinued operations included a Second Quarter net gain on the sale of the Miami Subs property of approximately $211,000, a Third Quarter net gain on the sale of a parcel of land located adjacent to the former vacant Twin Falls, ID property of $5,000 (the land had no recorded value), and Second and Fourth Quarter provisions for non-collectible rents and other receivables related to the Miami Subs property.

Revenues

Total operating revenues were $1,885,000, $1,929,000, and $2,068,000, for the years ended December 31, 2006, 2005, and 2004, respectively. During 2005 the Partnership received payments from Popeye’s totaling $35,000 relating to 2004 property tax recoveries. During 2004 the Partnership received payments from Popeye’s totaling $129,000 relating to property tax reimbursements and recoveries. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part I- Item 2, and Part II- Item 7.)

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As of December 31, 2006, total base operating rent revenues should approximate $1,453,000 for the year 2007 based on leases currently in place (does not include the Sunrise Preschool property which was classified as property held for sale in the Second Quarter of 2006). Future operating rent revenues may decrease with tenant defaults and/or the reclassification of Properties as held for sale. They may also increase with additional rents due from tenants, if those tenants experience sales levels, which require the payment of additional rent to the Partnership.

Expenses

For the years ended December 31, 2006, 2005, and 2004 total operating expenses amounted to approximately 44%, 40% and 40%, of total operating revenues, respectively.

The variance in operating expenditures are due to: (i) an unexpected insurance premium adjustment payment in the Second Quarter of 2006 of approximately $12,000 related to the 04/05 policy year, and Second through Fourth Quarter of 2006 accruals totaling $14,000 for estimated insurance premium adjustments related to the 05/06 and 06/07 policy years; (ii) higher income tax expenditures in the First through Third Quarters of 2006 related to the 2005 South Carolina tax return and the 2006 South Carolina estimated tax payments; (iii) higher professional service fees during 2006, such as data processing; (iv) a settlement payment of $25,000 paid in the Third Quarter of 2006 to the Buyer of the former South Milwaukee property (For further discussion see Legal Proceedings in Note 10 to Financial Statements and Part I- Item 3.); (v) the First through Third Quarter of 2005 total collections and revenue recognition of approximately $35,000 in property tax recoveries from Popeye’s (see Note 3- Investment Properties for further discussion) and (vi) a Third Quarter 2005 income tax liability accrual, payable to the City of Columbus, Ohio for the tax years 1999 through 2004. (vii) the Second through Fourth Quarter of 2004 collections and revenue recognition of $129,000 in property tax recoveries from Popeye’s (see Note 3- Investment Properties for further discussion; (viii) increased general and administrative expenditures related to investor communication, and increased professional expenditures, due to the 2005 Consent mailing in the Second Quarter of 2005; and (ix) the March 2004 payment of Popeye’s 2001 property taxes second installment and related penalties due to tenant default.

Depreciation and amortization are non-cash items and do not affect current operating cash flow of the Partnership or distributions to the Limited Partners.

There were no operating write-offs for non-collectible rents and receivables for the years ended December 31, 2006, 2005 and 2004. Such write-offs would primarily be the result of tenant defaults.

Other Income

For the years ended December 31, 2006, 2005, and 2004 the Partnership did generate other income of approximately $73,000, $37,000 and $49,000, respectively. During March of 2006 the Partnership received $25,000 from DiFede in satisfaction of the Judgment recorded in the Broward County, Florida Circuit Court in January of 2005. (See Investment Properties- Former Miami Subs- Palm Beach, FL Property in Note 3 to Financial Statements and Part I- Item 2.) During January 2004 the Partnership received a one-time settlement payment of approximately $25,000 from the Bankruptcy Court in relation to the DeDan bankruptcy litigation. In the late 1980’s, the Partnership leased some properties to DeDan, Inc., and the leases were guaranteed by the owner of DeDan, Dan Fore. These leases went into default in the early 1990’s and the Partnership obtained possession of the properties and re-leased them to various entities. The original lessee, DeDan and Dan Fore, filed for bankruptcy and the Partnership filed a claim in the Bankruptcy Court for damages incurred due to the lease defaults. (For further disclosure see Investment Properties in Note 3 to Financial Statements, Part II- Item 8, and Part I- Item 3.)

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During 2006, 2005 and 2004, revenues were generated from interest earnings and small recoveries from former General Partners. Management anticipates that such revenue types may continue to be generated until Partnership dissolution.

Inflation

Inflation has a minimal effect on operating earnings and related cash flows from a portfolio of triple net leases. By their nature, such leases actually fix revenues and are not impacted by rising costs of maintenance, insurance, or real estate taxes. Although the majority of the Partnership’s leases have percentage rent clauses, revenues from operating percentage rents represented only 23% of operating rental income for 2006. If inflation causes operating margins to deteriorate for lessees, or if expenses grow faster than revenues, then, inflation may well negatively impact the portfolio through tenant defaults.

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

Critical Accounting Policies

The Partnership believes that its most significant accounting policies deal with:

Depreciation methods and lives- Depreciation of the properties is provided on a straight-line basis over 31.5 years, which is the estimated useful life of the buildings and improvements. While the Partnership believes these are the appropriate lives and methods, use of different lives and methods could result in different impacts on net income. Additionally, the value of real estate is typically based on market conditions and property performance, so depreciated book value of real estate may not reflect the market value of real estate assets.

Revenue recognition- Rental revenue from investment properties is recognized on the straight-line basis over the life of the respective lease. Percentage rents are accrued only when the tenant has reached the sales breakpoint stipulated in the lease.

Impairment- The Partnership periodically reviews its long-lived assets, primarily real estate, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership’s review involves comparing current and future operating performance of the assets, the most significant of which is undiscounted operating cash flows, to the carrying value of the assets. Based on this analysis, a provision for possible loss is recognized, if any.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

The Partnership is not subject to market risk.

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Item 8. Financial Statements and Supplementary Data

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

(A Wisconsin limited partnership)

INDEX TO FINANCIAL STATEMENTS AND SCHEDULE

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Report of Independent Registered Public Accounting Firm

Partners of

Divall Insured Income Properties 2 Limited Partnership

We have audited the balance sheet of Divall Insured Income Properties 2 Limited Partnership (a Wisconsin limited partnership) as of December 31, 2006 and the related statements of income, partners’ capital, and cash flows for the year then ended. Our audit also included the 2006 financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Divall Insured Income Properties 2 Limited Partnership at December 31, 2006, and the results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ MCGLADREY & PULLEN, LLP

Chicago, Illinois

March 28, 2007

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Report of Independent Registered Public Accounting Firm

Partners of

DiVall Insured Income Properties 2 Limited Partnership

We have audited the accompanying balance sheet of DiVall Insured Income Properties 2 Limited Partnership (a Wisconsin limited partnership) as of December 31, 2005, and the related statements of income, partners’ capital, and cash flows for the years ended December 31, 2005 and 2004. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the DiVall Insured Income Properties 2 Limited Partnership as of December 31, 2005, and the results of its operations and its cash flows for the years ended December 31, 2005 and .2004, inconformity with U.S. generally accepted accounting principles.

/s/ ALTSCHULER, MELVOIN AND GLASSER LLP

Chicago, Illinois

January 20, 2006, except for Note 12

    as to which the date is February 15, 2005

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

BALANCE SHEETS

December 31, 2006 and 2005

ASSETS

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

BALANCE SHEETS

December 31, 2006 and 2005

LIABILITIES AND PARTNERS’ CAPITAL

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

STATEMENTS OF INCOME

For the Years Ended December 31, 2006, 2005, and 2004

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

STATEMENTS OF PARTNERS’ CAPITAL

For the years ended December 31, 2006, 2005 and 2004

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2006, 2005, and 2004

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 2006, 2005 AND 2004

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES:

DiVall Insured Income Properties 2 Limited Partnership was formed on November 18, 1987, pursuant to the Uniform Limited Partnership Act of the State of Wisconsin. The initial capital, contributed during 1987, consisted of $300, representing aggregate capital contributions of $200 by the former general partners and $100 by the Initial Limited Partner. The minimum offering requirements were met and escrowed subscription funds were released to the Partnership as of April 7, 1988. On January 23, 1989, the former general partners exercised their option to increase the offering from 25,000 interests to 50,000 interests and to extend the offering period to a date no later than August 22, 1989. On June 30, 1989, the general partners exercised their option to extend the offering period to a date no later than February 22, 1990. The offering closed on February 22, 1990, at which point 46,280.3 interests had been sold, resulting in total offering proceeds, net of underwriting compensation and other offering costs, of $39,358,468.

The Partnership is currently engaged in the business of owning and operating its investment portfolio of commercial real estate properties (the “Properties”.) The Properties are leased on a triple net basis to, and operated by, franchisors or franchisees of national, regional, and local retail chains under long-term leases. The lessees are primarily fast food, family style, and casual/theme restaurants, but also include a video rental store and a pre-school. At December 31, 2006, the Partnership owned 19 properties with specialty leasehold improvements in six (6) of these properties.

Rental revenue from investment properties is recognized on the straight-line basis over the term of the respective lease. Percentage rents are only accrued when the tenant has reached the sales breakpoint stipulated in the lease.

Tenant accounts receivable are comprised of billed but uncollected amounts due for monthly rents and other charges, and amounts due for scheduled rent increases for which rentals have been earned and will be collected in the future under the terms of the leases. Receivables are recorded at management’s estimate of the amounts that will be collected.

As of December 31, 2006 and 2005, there were no recorded values for allowance for doubtful accounts based on an analysis of specific accounts and historical experience.

The Partnership considers its operations to be in only one segment, the operation of a portfolio of commercial real estate leased on a triple net basis, and therefore no segment disclosure is made.

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

Deferred charges represent leasing commissions paid when properties are leased and upon the negotiated extension of a lease. Leasing commissions are capitalized and amortized over the term of the lease.

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Property taxes, insurance and ground rent on the Partnership’s investment properties are the responsibility of the tenant. However, when a tenant fails to make the required tax payments or when a property becomes vacant, the Partnership makes the appropriate payment to avoid possible foreclosure of the property. Such taxes, insurance and ground rent are accrued in the period in which the liability is incurred. The Partnership owns one (1) restaurant, which is located on a parcel of land where it has entered into a long-term ground lease. The tenant, Kentucky Fried Chicken, is responsible for the $3,400 per month ground lease payment.

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

Financial instruments that potentially subject the Partnership to significant concentrations of credit risk consist principally of cash investments. The Partnership generally maintains cash and cash equivalents in federally insured accounts.

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

Assets disposed of or deemed to be classified as held for sale require the reclassification of current and previous years’ operations to discontinued operations in accordance with Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144).

In March 2005, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations”, an interpretation of SFAS No. 143, which clarifies that a liability for the performance of an asset retirement activity should be recorded if the obligation to perform such activity is unconditional, whether or not the timing or method of settlement may be conditional on a future event. FIN 47 was effective no later than the end of the fiscal year ending after December 15, 2005. FIN 47 did not have a significant impact on the Partnership’s financial statements.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Partnership does not expect the adoption of FIN 48 to have a material impact on its financial statements.

The Partnership periodically reviews its long-lived assets, primarily real estate, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership’s review involves comparing current and future operating performance of the assets, the most significant of which is undiscounted operating cash flows, to the carrying value of the assets. Based on this analysis, a provision for possible loss is recognized, if any.

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During 2006, 2005 and 2004, the Partnership recognized income from discontinued operations of approximately $112,000, $921,000 and $495,000, respectively. The 2006 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property to property held for sale in the Second Quarter of 2006. The 2005 and 2004 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property in the Second Quarter of 2006 and the Hooter’s restaurant property (which was sold in December 2005). The 2004 income from discontinued operations is also attributed to the Miami Subs property (which was sold in June 2004).

The components of property held for sale in the condensed balance sheets as of December 31, 2006 and 2005 are outlined below.

The components of discontinued operations included in the statements of income for the years ended December 31, 2006, 2005 and 2004 are outlined below.

The Partnership will be dissolved on November 30, 2010, or earlier upon the prior occurrence of any of the following events: (a) the disposition of all properties of the Partnership; (b) the written determination by

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the General Partner that the Partnership’s assets may constitute “plan assets” for purposes of ERISA; (c) the agreement of Limited Partners owning a majority of the outstanding interests to dissolve the Partnership; or (d) the dissolution, bankruptcy, death, withdrawal, or incapacity of the last remaining General Partner, unless an additional General Partner is elected previously by a majority of the Limited Partners. During the Second Quarters of 2001, 2003 and 2005, consent solicitations were circulated (the “2001, 2003 and 2005 Consents, respectively”), which if approved would have authorized the sale of the Partnership’s assets and dissolution of the Partnership. A majority of the Limited Partners did not vote in favor of either the 2001, 2003 or 2005 Consents. Therefore, the Partnership continued to operate as a going concern. The bi-annual consent solicitation is scheduled to be mailed in May of 2007, which if approved would authorize the sale of the Partnership’s assets and dissolution of the Partnership.

No provision for federal income taxes has been made, as any liability for such taxes would be that of the individual partners rather than the Partnership. At December 31, 2006, the tax basis of the Partnership’s assets exceeded the amounts reported in the accompanying financial statements by approximately $6,862,000.

The following represents an unaudited reconciliation of net income as stated on the Partnership statements of income to net income for tax reporting purposes:

2. REGULATORY INVESTIGATION:

A preliminary investigation during 1992 by the Office of Commissioner of Securities for the State of Wisconsin and the Securities and Exchange Commission (the “Investigation”) revealed that during at least the four years ended December 31, 1992, the former general partners of the Partnership, Gary J. DiVall (“DiVall”) and Paul E. Magnuson (“Magnuson”) had transferred substantial cash assets of the Partnership and two affiliated publicly registered limited partnerships, DiVall Insured Income Fund Limited Partnership (“DiVall 1”) and DiVall Income Properties 3 Limited Partnership (“DiVall 3”) (collectively the “Partnerships”) to various other entities previously sponsored by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers were in violation of the respective Partnership Agreements and resulted, in part, from material weaknesses in the internal control system of the Partnerships.

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

In 1993, the current General Partner estimated an aggregate recovery of $3 million for the Partnerships. At that time, an allowance was established against amounts due from former general partners and their affiliates reflecting the estimated $3 million receivable. This net receivable was allocated among the Partnerships based on each Partnership’s pro rata share of the total misappropriation, and restoration costs and recoveries have been allocated based on the same percentage. Through December 31, 2006, $5,861,000 of recoveries have been received which exceeded the original estimate of $3 million. As a result, from January 1, 1996 through December 31, 2006, the Partnership has recognized a total of $1,173,000 as income, which represents its share of the excess recovery. The current General Partner continues to pursue recoveries of the misappropriated funds, however, no further significant recoveries are anticipated.

3. INVESTMENT PROPERTIES:

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

As of December 31, 2006, the Partnership owned properties containing17 fully constructed fast-food restaurants, a video store, and a preschool (all of which are owned and operated by entities unaffiliated with the Partnership). The 19 properties are composed of the following: ten (10) Wendy’s restaurants, one (1) Denny’s restaurant, one (1) Applebee’s restaurant, one (1) Popeye’s Famous Fried Chicken restaurant, one (1) Kentucky Fried Chicken restaurant, one (1) Chinese Super Buffet restaurant, one (1) Blockbuster Video, one (1) Sunrise Preschool (classified as property held for sale in June of 2006), one (1) Panda Buffet restaurant, and one (1) Daytona’s- All Sports Café. The 19 properties are located in a total of nine (9) states.

On January 1, 2002, the Partnership adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This statement requires current and historical results from operations for disposed properties and assets classified as held for sale that occur subsequent to January 1, 2002 to be reclassified separately as discontinued operations.

Income from discontinued operations was approximately $112,000, $921,000 and $495,000 for the years ended December 31, 2006, 2005, and 2004, respectively. The 2006 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property to property held for sale in the Second Quarter of 2006. The 2005 and 2004 income from discontinued operations is attributable to the reclassification of the Sunrise Preschool- Phoenix, AZ property in the Second Quarter of 2006 and the sale of the Hooters’s- Richland Hills, TX property in December of 2005. The 2004 income from discontinued operations is also attributable to the sale of the Miami Subs- Palm Beach, FL property

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in June of 2004. The 2005 income from discontinued operations included a Fourth Quarter net gain on the sale of the Hooter’s restaurant property of approximately $668,000. The 2004 income from discontinued operations included a Second Quarter net gain on the sale of the Miami Subs property of approximately $211,000, a Third Quarter net gain on the sale of a parcel of land located adjacent to the former vacant Twin Falls, ID property of $5,000 (the land had no recorded value), and Second and Fourth Quarter provisions for non-collectible rents and other receivables related to the Miami Subs property.

The following summarizes significant developments, by property, for properties with such developments.

Sunrise Preschool- Phoenix, AZ Property

A listing agreement for the sale of the property was executed in June 2006. In early January 2007, a sales contract was executed for the sale of the property for $1.6 million. Per notice from the Partnership, tenant, Borg Holdings, Inc. (“Borg”), had 30 days from January 16, 2007, to act upon their right of first refusal to purchase the Phoenix property, since a separate buyer entered into a real estate contract for the purchase of the property. On January 29, 2007, Borg informed the Partnership that they would be exercising their right to accept the terms of the contract for the sale of the Phoenix, AZ property. Closing is anticipated to be during the summer of 2007 and commissions totaling 6%, which includes 2% to a General Partner affiliate, are expected to be paid. The net book value of the property at December 31, 2006, classified as property held for sale, was approximately $617,000, which included $241,000 related to land, $386,000 related to buildings and improvements, and $10,000 related to security deposits.

Ogden, UT property

The Blockbuster lease on the current 6,000 square foot space expired on January 31, 2006. During lease renewal negotiations with Management, the tenant maintained possession of the property and paid the Partnership holdover rent for February and March 2006. In April 2006, Management executed a two-year renewal lease agreement with the tenant, retroactive to February 1, 2006. The first base year rent will total $108,000. Leasing commissions related to the lease renewal execution totaled approximately $13,000, ($6,500 paid to a non-affiliated broker and $6,500 paid to a General Partner affiliate).

Grand Forks, ND Property

On January 24, 2006, the owners of the Panda Buffet Restaurant in Grand Forks, ND gave notice to Management that they intended to exercise their purchase option in relation to the property. A sales contract was executed on February 27, 2006 for the sale of the Grand Forks, ND property at a sales price of $525,000. Although closing was anticipated to be in the First Quarter of 2006, the sale was not consummated and the sales contract expired in late March 2006. The original lease, which is set to expire in 2013, remains effective and includes the tenant’s option to purchase the property.

Popeye’s- Park Forest, IL

As of December 31, 2006, Popeye’s is delinquent on its April and May 2006 rent obligations and property taxes escrow payments totaling approximately $13,000 and $10,000, respectively. These unpaid amounts are accrued for at December 31, 2006. As of December 31, 2006, the tenant has a property tax escrow cash balance held with the Partnership of approximately $12,000. The Partnership received the required June through December 2006 rent and property taxes escrow payments.

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In the Second Quarter of 2006, Management defaulted Popeye’s for failure to meet its lease obligations, and filed for possession of the Park Forest property in the Cook County Judicial Court. The Partnership continues the pursuit of all legal remedies available to recover possession and terminate the Lease. Popeye’s remains responsible for monthly rent obligations and property taxes through the remainder of its Lease (expires December 31, 2009).

A Release and Settlement Agreement was executed with Popeye’s in November 2004. In settlement of all claims and disputes the following significant items were agreed to: (i) Popeye’s is to make monthly escrow property taxes payments applicable to 2004 and for future property taxes installments due throughout the remaining lease term obligation; (ii) Popeye’s gross sales breakpoint was increased to $1,000,000 and therefore, percentage rent shall be an amount equal to 8% of gross sales in excess of $1,000,000, and (iii) Popeye’s delinquent percentage rents were waived.

During 2004, property taxes escrow charges applicable to 2004 property taxes were reflected in the financial statements as escrow payments were actually received, and were recorded as a reversal of 2004 property taxes expense equal to the amount of payment received. The Partnership recognized property taxes recovery income of approximately $129,000 during 2004, which related to Popeye’s reimbursement to the Partnership of defaulted property taxes and penalties that had been previously expensed and paid by the Partnership. During 2005, property taxes escrow charges applicable to property taxes previously accrued and expensed in 2004, were reflected in the financial statements as escrow payments were actually received, and were recorded as property taxes recovery income equal to the amount of payment received. Property taxes recovery income during 2005 totaled approximately $35,000. Due to Popeye’s full reimbursement to the Partnership for past property taxes paid on the tenant’s behalf, and Popeye’s agreement to meet billing and escrow obligations, the 2005 and 2006 estimated property taxes were not expensed and accrued as of December 31, 2005 and 2006, respectively.

4785 Merle Hay Road- Des Moines, IA

In September 2005, the Partnership paid Daytona’s- All Sports Cafés (“Daytona’s”) first installment of its 2004 property taxes, which amounted to approximately $10,000. Daytona’s reimbursed the Partnership in the Fourth Quarter of 2005. Beginning in December 2005, Management requested that Daytona’s escrow its future property taxes liabilities with the Partnership on a monthly basis. Daytona’s remains current on its property tax escrow obligations. As of December 31, 2006, escrow payments held by the Partnership totaled approximately $18,000.

Former Miami Subs- Palm Beach, FL Property

The Palm Beach, FL property was sold in June 2004. At the time of closing the former tenant, DiFede Finance Group (“DiFede”), was delinquent $17,000 in past rent (after the application of a $15,000 security deposit). The former tenant also owed the Partnership approximately $13,360 in property taxes as the Partnership paid the property’s delinquent 2003 property taxes in June 2004. Management continued to pursue legal remedies to collect the former tenant’s total past due balances. Due to the uncertainty of collection, fifty percent (50 %) of the total outstanding receivable balance was reserved in June 2004.

In November 2004, a Settlement Agreement (“DiFede Agreement”) was executed with DiFede. Per the DiFede Agreement the former tenant agreed to pay the Partnership by December 31, 2004 approximately $36,000 in past due rent, late charges, related attorney and court fees and other miscellaneous items. However, the settlement payment per the DiFede Agreement was not received by the Partnership. Further

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legal action was taken by the Partnership and the Circuit Court in Broward County, Florida entered a final judgment (the “Judgment”) against DiFede in early January 2005, awarding approximately $42,000 in damages to the Partnership. Due to the uncertainty of collection, the remaining fifty percent (50 %) of the total outstanding receivable balance was written-off. The receivable balance and applicable allowance were removed from the balance sheet at December 31, 2004. Throughout 2005, Management continued their pursuit of legal action to collect the Judgment. In satisfaction of the Judgment (which was recorded in the Circuit Court in March 2006), the Partnership received $25,000 from Difede in the First Quarter of 2006.

Former Hooter’s- Richland Hills, TX

A sales contract was executed in October of 2005 for the sale of the property in the Fourth Quarter of 2005 at a sales price of $1,575,000. The closing date on the sale of the property was December 2005 and the net sales proceeds totaled approximately $1,505,000. A net gain on the sale of $668,000 was recognized in the Fourth Quarter of 2005. Closing and other sale related costs amounted to $70,000, which included a sales commission paid to a General Partner affiliate totaling $47,250.

Former Twin Falls, ID property

In August 2004, the Partnership sold a piece of land adjacent to the former Twin Falls property for $5,000. The land had no recorded value.

Other Investment in Properties Information

According to the Partnership Agreement, the former general partners were to commit 80% of the original offering proceeds to investment in properties. Upon the close of the offering, approximately 75% of the original proceeds were invested in the Partnership’s properties.

At December 31, 2005, the tenant of the Panda Buffet property had an option to purchase the property at a price, which (i) exceeded the original cost of the property less accumulated depreciation and (ii) was not less than the fair market value of the property at the time the option was granted. On January 24, 2006, the owners of the Panda Buffet Restaurant in Grand Forks, ND gave notice to Management that they intended to exercise their purchase option in relation to the property, but the proposed sale was not consummated. (For further discussion see “Grand Forks, ND Property” above.) The original lease, which is set to expire in 2013, remains effective and includes the tenant’s option to purchase the property. The General Partner is not aware of any unfavorable purchase options in relation to the original cost or fair market value of the property at the time the option was granted, contained in any of the Partnership’s existing leases.

4. PARTNERSHIP AGREEMENT:

The Partnership Agreement, prior to an amendment effective May 26, 1993, provided that, for financial reporting and income tax purposes, net profits or losses from operations were allocated 90% to the Limited Partners and 10% to the general partners. The Partnership Agreement also provided for quarterly cash distributions from Net Cash Receipts, as defined, within 60 days after the last day of the first full calendar quarter following the date of release of the subscription funds from escrow, and each calendar quarter thereafter, in which such funds were available for distribution with respect to such quarter. Such distributions were to be made 90% to Limited Partners and 10% to the former general partners, provided, however, that quarterly distributions were to be cumulative and were not to be made to the former general

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partners unless and until each Limited Partner had received a distribution from Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return on his or her Adjusted Original Capital, as defined, from the Return Calculation Date, as defined.

Net Proceeds, as originally defined, were to be distributed as follows: (a) to the Limited Partners, an amount equal to 100% of their Adjusted Original Capital; (b) then, to the Limited Partners, an amount necessary to provide each Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative simple return on Adjusted Original Capital from the Return Calculation date including in the calculation of such return all prior distributions of Net Cash Receipts and any prior distributions of Net Proceeds under this clause; and (c) then, to Limited Partners, 90% and to the General Partners, 10%, of the remaining Net Proceeds available for distribution.

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

The provisions regarding distribution of Net Proceeds, as defined, were also amended to provide that Net Proceeds are to be distributed as follows: (a) to the Limited Partners, an amount equal to 100% of their Adjusted Original Capital; (b) then, to the Limited Partners, an amount necessary to provide each Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative simple return on Adjusted Original Capital from the Return Calculation Date including in the calculation of such return on all prior distributions of Net Cash Receipts and any prior distributions of Net Proceeds under this clause, except to the extent needed by the General Partner to pay its federal and state income tax on the income allocated to it attributable to such year; and (c) then, to Limited Partners, 99%, and to the General Partner, 1%, of remaining Net Proceeds available for distribution.

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

Effective June 1, 1993, the Partnership Agreement was amended to (i) change the definition of “Distribution Quarter” to be consistent with calendar quarters, and (ii) change the distribution provisions to subordinate the General Partner’s share of distributions from Net Cash Receipts and Net Proceeds, except

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to the extent necessary for the General Partner to pay its federal and state income taxes on Partnership income allocated to the General Partner. Because these amendments do not adversely affect the rights of the Limited Partners, pursuant to section 10.2 of the Partnership Agreement, the General Partner made the amendments without a vote of the Limited Partners.

5. LEASES:

Original lease terms for the majority of the investment properties are generally 10 - 20 years from their inception. The leases generally provide for minimum rents and additional rents based upon percentages of gross sales in excess of specified breakpoints. The lessee is responsible for occupancy costs such as maintenance, insurance, real estate taxes, and utilities. Accordingly, these amounts are not reflected in the statements of income except in circumstances where, in management’s opinion, the Partnership will be required to pay such costs to preserve its assets (i.e., payment of past-due real estate taxes). Management has determined that the leases are properly classified as operating leases; therefore, rental income is reported when earned on a straight-line basis and the cost of the property, excluding the cost of the land, is depreciated over its estimated useful life.

As of December 31, 2006, the aggregate minimum operating lease payments to be received under the current operating leases for the Partnership’s properties are as follows (does not include the Sunrise Preschool- Phoenix, AZ property which was classified as property held for sale in the Second Quarter of 2006):