The Section 1231 netting results in an ordinary loss deduction of $9,000, reducing Fred’s taxable income by $9,000.

Step 1 Netting:

Net casualty gain                                        $    5,000

Step 2 Netting:

Net casualty gain from step 1                     $    5,000

Section 1231 gains                                            3,000

Section 1231 losses                                       (17,000)

Net section 1231 loss                                  $   (9,000)

The net casualty gain from step 1 is combined with other Section 1231 gains and losses in step 2.  This allows the net casualty gain to be offset against other Section 1231 gains and losses.  Because there is a net Section 1231 loss for the year, there is no lookback recapture rule to apply.