Thought of posting this since my cleric friend trying to attack land mobs when she flies in air..
Damage reduction is applied when:
1) mobs are 3 or higher level than the attacker
2) attacker is not on the same terrain as the mobs
3) exception includes: veno's pets, mystic's summons, and damage over time (DoT) such as poison, burn, bleed, and etc..
4) any attacker holding range weapon (bow, crossbow, slingshot) will get damage reduction if the distance between attacker and mobs are 5.5 meters or less (crossbow), 5 meters or less (bow), and 4.5 meters or less (slingshot).. If you don't know what 5 meters is, it's basically 2 walking steps away from mobs..
1) mobs are 3 or higher level than the attacker
* within 3 levels or higher level than mobs: NO damage reduction (3 or more levels above the mobs is color coded leaf green; within 3 levels of the attacker is color coded white)
* 3 to 5 levels higher: 10% damage reduction (color coded yellow)
* 6 to 8 levels higher: 20% damage reduction (color coded light orange)
* 9 to 11 levels higher: 30% damage reduction (color coded light orange)
* 12 to 15 levels higher: 40% damage reduction (color coded light orange)
* 16 to 20 levels higher: 50% damage reduction (color coded dark orange)
* more than 20 levels : 75% damage reduction (color coded very dark orange)
Orange color gets darker when the mobs are higher level..
In hitting mobs, defense (for APS characters) and magic defense (for spellcasters) of the mobs are also applied in addition to damage reduction.. For APS character, accuracy of the attacker and evasion of the mobs are also taken into consideration for the miss-hit situation..
2) attacker is not on the same terrain as the mobs
*Air mobs: only attack from land or air (attacking from water results in 50% damage reduction)
*Land mobs: only attack from land (anywhere else gives 50% damage reduction, attacking from water causes land mobs to flee away from attacker)
*Water mobs: only attack from water (anywhere else gives 50% damage reduction, attacking from land or air causes water mobs to flee away from attacker --> yes, water mobs can't survive other terrains, they're not gonna chase you to land just to kill you)
3) Pets, summons, and DoT damage do not get damage reduction because of different terrains and/or levels.. However, pets and summons have their own accuracy stat.. If the mobs is lvl 80 and attacker is lvl 20, pets will hit constant misses because their accuracy isn't high enough to overcome mobs' evasion.. Same true with DoTs.. If your DoT attack misses, the DoT effect doesn't apply..
??? refers to lvl 150 mobs (best taken care of by pets since you most likely won't hit anything/hitting misses/hitting very low damage, and etc)..
4) Self-explanatory.. 10 meters or less are considered melee range (mostly barb, seekers, sin, BM, veno's melee pet, mystic's melee summons), 10-25 meters are medium range (usually for wizard, cleric, veno, mystic, psychic), 25 meters+ are long range (archer)..
Sources:
http://pwi-wiki.perfectworld.com/index.php/Damage