If you refinance or take a second mortgage on your house to come up with the $$ to buy the lot (or a car or the pay off a credit card), and your house still has some equity left, you can write off all the interest you pay on Schedule A. If you get one of those "125% of your home's equity" loans, you can only write off the amount of interest paid on the home's value.
Ex. House is worth $100,000 and has a mortgage of $50,000. If you buy the land for $50,000 or less using a second mortgage, you can write off the interest. If you had a mortgage of $80,000, you can only deduct only 100/130 of the interest paid. You have to adjust the deductable interest each year to reflect the debt and fair market values of the house. Eventually, all of the interest will be deductable.
