Background. The temporal relationship between depression and adverse functional outcomes in older adults is ambiguous. In the present eight-wave prospective community-based study, the longitudinal effect of depression on functional limitations and disability (in terms of disability days and bed days) was studied, thereby taking into account the role of chronic physical diseases. Methods. The study is based on a sample which at the outset consisted of 325 non-depressed and 327 depressed persons (55-85 years) drawn from a larger random community based sample in the Netherlands. Generalized estimating equations time-lag models were used to examine the longitudinal relation between depression and both functional limitations and disability. Results. Functional limitations were very persistent over time, whereas disability days and bed days were more fluctuating functional outcomes. Only in the presence of chronic physical diseases, there was a significant longitudinal association between depression at the previous measurement and functional limitations, disability days and bed days at the next measurement. The effect on functional limitations was small, which was probably partly due to their persistent nature. Conclusions. The finding of a longitudinal relationship between depression and functional outcomes in older adults with a compromised health status provides a rationale for treatment of chronic physical diseases as well as depression in depressed chronically ill elderly, in order to prevent a spiralling decline in psychological and physical health.