It happens on a Wednesday afternoon when Sunny suggests to burn down the hotel as a way to keep its occupants from getting infected with the Medusoid Mycelium. It is used by the Baudelaire children in order to signal to Kit Snicket and other volunteers who will be "watching the skies" that the Hotel Denouement is no longer safe.
Count Olaf started the fire in the Laundry Room of the hotel, using the dirty laundry sheets and Jerome Squalor's book Odious Lusting After Finance as kindling.
Using a trick that their parents taught them, the Baudelaires stopped at every floor so that they and Justice Strauss can warn everyone about the fire while Count Olaf claims that the fire is a fake. It was not mentioned who believed the Baudelaires, who believed Count Olaf, and who believed Justice Strauss.
Count Olaf, his hostage Justice Strauss, and the Baudelaires are in the Laundry room. Klaus helps unlock the door, Violet plans a way to escape and Sunny says "burn down the hotel." Olaf takes Odious Lusting After Finance, pours chemicals onto the sheets, and sets them on fire.
It is unclear who survived the fire, although Justice Strauss and the Trolleyman are confirmed to have survived.