For what activities would you be using the two spaces?

Our activities would be watching tv, playing games and motion sensor games so space to move around would be good. I wasn't sure if adding two chair near the fireplace would be good idea. We were also thinking about having wall unit built into the alcove. Thanks for your feedback!

20 x 20 isn't really that huge. Definitely should consider making in the big TV hole cohesive with the FP, if that's where you want to consider keeping the TV. Surround w/ built-in cabinets or bookcases to keep it from looking so lost. The current TV hole is dragging the whole space down & needs to be addressed (if you need cheap solution, put nice-looking doors or mirrored doors on it & turn it into a closet or dry-bar). Like prior posters' idea to move TV to the left side across from the windows

I/m assuming from giant teddy & what appears to be a bouncy chair (or some such accoutrement) that you have small ones. A screen would work well to segment off a corner of the area (perhaps TV space?) for toddler activities (would need to relo TV) . Also, a trunk or other quick "stash spot" for toys would be key. You need to decide what your primary focal point should be - TV or FP & work couch position around that.

It's pretty easy to divide a large space w/ a couch (& preferably a library or sofa table or desk, behind it) to chop a big space in half. Rugs on top of carpet can help too.

Since your pic only shows 2 of 4 walls, it's hard to get a grasp on the whole space, but by the look of things you have limited furniture, so I'd definitely follow prior advice to float sofa in the middle of the room - facing FP or TV or anything else of your choosing. Personally, I like 2 chairs w/ a draped table b/t for corners. you can hide toy stash box under the drape.

By looks of your photos, you need to have your carpets re-stretched which will make them look new at a fraction of the cost of new.

Additional pic

I think the idea of building a wall unit into the alcove is a great idea, and I would place the TV in there. That could be the "gaming" watching TV side of the room, and the other half could be for visiting and lounging. The fireplace will still be the main focal point of the room. The idea is to create separate areas but at the same time maintain a cohesive design. Think of decorating in the round rather than along the outside walls, think layering. Try to keep traffic patterns open. Instead of a chairs in front of the fireplace consider a long upholstered/tufted bench (without a back) in that place, people can sit on the ends or in the center facing either direction. If I am reading the color correctly this color looks great with aqua blue and a coppery orange for a contemporary look, or with chocolate browns for a more traditional look.

Yes, that alcove is screaming for a built-in media cabinet (see attached photo for an example). One great way to divide the space is to have a large sectional with the back floating as a divider in the room. The sectional would be facing the media cabinet and fireplace, making that side of the room the family room. On the other side of the room, you could have a more intimate and formal seating area with a couple of nice chairs and an area rug to define the space. You could have a console/sofa table behind the sectional to further divide the space and provide some visual interest (with accessories) for the more formal side of the room.

This new picture is very helpful. Looks like you really need to keep tv in alcove as the wall opposite window is only a partial wall (stairway). Consider placing sofa at 45 degree angle from beginning of stairway landing facing toward the tv.

Diagonals add energy to a room and are actually a great use of space. Like the idea of doors or cabinet for the alcove. Maybe you can have your tv mounted on wall inside alcove with the ability to be pulled out and angled for viewing.

I'd beef up the FP (it has to compete with the large tv area). Maybe you can have it refaced with much more substantial woodwork to cover a larger wall area.

Looks like your white chair would fit nicely into fp corner. This whole seating arrangement could be anchored by an area rug. Get a large, distressed wood coffee table for game playing. The rug will add softness for sitting on floor and catch spills.

A couple of nice extra wide chairs with a table between would fit nicely under window area and be a good place for reading to the little ones.

always think of creating a few seating areas, like groupings. Sarah Richardson does it best, check her out. http://www.hgtv.ca/sarah101/episodes.aspx?sectionid=432&categoryid=6717467639485193846&postid=300965