This phrase is usually used sarcastically when someone is laughing at you.
It is famously used in the movie The Empire Strikes Back when Han Solo says to his friend Chewbacca “Laugh it up, fuzzball.” http://www.youtube.com/watch?v=gqbdrA1Vjn4
When used in this sarcastic manner, you could also say something like:
“Go ahead and laugh” or “Yeah? You think that’s funny?”
On the other hand, while rarer, it could be used in a non-sarcastic way such as “We went to the comedy club and really laughed it up.” In this context, any saying that implies a good time would work, such as:
“We laughed all night long” or “We couldn't stop laughing.”