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I dropped in on a couple co-op games in the beta today and the first thing I noticed was that everyone wasn't running for loot. This is a thing of the past, apparently, as any loot that you can see is yours and yours alone.

That said, is there a limit to when loot drops for me during co-op play? Does it drop when I'm in town or if I'm around but I don't hit an enemy before it's killed?

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Things I can confirm are dropped while a player is in town are items from world containers such as weapon racks and dead villagers. Items from monsters do not seem to drop for players who are in town. – user9983 Feb 5 '12 at 18:54
@OrigamiRobot I thought your answer was more complete, why delete it? – authenticgeek Feb 22 '12 at 21:20
It was incomplete and I could not devote the time to completing it. I converted it to a comment to help future answerers. – user9983 Feb 22 '12 at 21:48
Actually, I've been in town plenty of times. And I've zoned to my buddy. And loot was there that shouldn't of been. So I think this system isn't really complete... That or some loot is given as a cheers – Paul R Buck Jul 4 '12 at 20:13
up vote 12 down vote accepted

Loot drops for you only off of those monsters that die within a certain distance of your character. Bashiok (Diablo 3 CM) confirms this with a tweet (link).

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It should be noted that treasure chests will drop loot for a player regardless of their location. I once joined a game and when I teleported to someone, there was an open treasure chest with loot on the ground a short distance away for me. Also per OrigamiRobot, weapon racks and dead villagers behave the same way. – Rachel May 23 '12 at 15:18

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