Tax deductions vary by jurisdiction, but I'm assuming you mean the IRS federal income tax deduction for mortgage interest. The IRS has detailed guidelines on how to handle various living situations, but they can be quite complex and often confusing.
The key here is that to be deductible, the interest must be paid on a loan collateralized by a qualified home; generally, this means one primary home and possibly one secondary home. Only homes you actually live in can be used as qualified homes, so the pond for Donald's mother wouldn't qualify.
Donald and Daisy didn't mortgage the pond, though; they took out a home equity loan on their own residence, which is a qualified home. Therefore, the loan is collateralized by a qualified home, and is therefore tax deductible.
There's another caveat, which is that home equity debt is only deductible up to $100,000 per household, so only the interest paid on $100,000 of that $140,000 is deductible. It's 5% interest, so that's $5,000 deductible and $2,000 not.
There is also a $1 million per household cap on acquisition mortgages, but they're well under that limit.
Thus, the deductible interest is $18,500 for the acquisition mortgage and $5,000 for the home equity mortgage, for a total of $23,500. The remaining $2,000 on the home equity mortgage is above the cap and therefore not deductible.
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