Dot1 (Disruptor of telomeric silencing-1) is a histone H3 lysine 79 methyltransferase that contributes to the establishment of heterochromatin boundary and has been linked to transcription elongation. We found that histone H4 N-terminal domain, unlike other histone tails, interacts with Dot1 and is essential for H3 K79 methylation. Furthermore, we show that the heterochromatin protein Sir3 inhibits Dot1-mediated methylation and that this inhibition is dependent on lysine 16 of H4. Sir3 and Dot1 bind the same short basic patch of histone H4 tail, and Sir3 also associates with the residues surrounding H3 K79 in a methylation-sensitive manner. Thus, Sir3 and Dot1 compete for the same molecular target on chromatin. ChIP analyses support a model in which acetylation of H4 lysine 16 displaces Sir3, allowing Dot1 to bind and methylate H3 lysine 79, which in turn further blocks Sir3 binding/spreading. This draws a detailed picture of the succession of molecular events occurring during the establishment of telomeric heterochromatin boundaries.