Put some shelves in it and use like the rest of the shelving.

Can you post a wider shot of the space so we can see what's around it?

Sorry, I assumed the mantel was being removed. The only thing I can think of that wouldn't resemble a former fireplace while still keeping the mantel would be to convert it to a playhouse or reading nook for your kids. You could install a cornice like cover or awning over the mantel. Here are some examples: http://4.bp.blogspot.com/-rt5PcMt8-3k/Uf6kxxInQFI/AAAAAAAAOOg/sTfLCzCYWT4/s1600/market+7.jpg

https://s-media-cache-ak0.pinimg.com/736x/cc/30/94/cc3094974b17b24a9115b5df27b6f2fc.jpg

http://www.designdazzle.com/wp-content/uploads/2012/11/kids-reading-nook5.jpg

I wouldn't use metal like in this picture but it gives a good visual of how you can install with an L-bracket: http://www.shanty-2-chic.com/wp-content/uploads/2015/07/DIY-Corrugated-Metal-Awning.jpg

…or if you want to go all out and cover both levels…

Here's an impressive and adorable market: http://www.lilblueboo.com/2012/01/project-playroom-the-market-awning.html

If you can find one that fits, put in an electric fireplace insert - especially since you already have the plug right there. There are many different styles. We put a glass front one in our basement fireplace and it was just a bit small all the way around so I built a fireplace surround of millwork, painted black, to cover the gap. The newer models have a realistic flame and you can turn the heat on or just have the "fire".

AKDY Electric Fireplace 33" Firebox Heater Freestanding Insert AK-ZEF0533R · More Info

Try creating an idea book called Home and upload your pics to that. Then we can open your profile to see the rest of the space.

Thanks for the pics! Without question, I would remove the mantel. Even if you get a gas insert, the mantel will still be too much. It dwarfs the window on the right. I'd probably remove the shelves too but you can definitely work with them. I would just beef them up a bit.

As nice as the fireplace would be, I'd be careful to jump the gun, especially since you were worried about the cost. You'll have drywall to install above and below, trim to remove/install, and paint to match, which can lead to painting an entire room. The costs may not seem like much but they will add up. I would wait until you're settled to do it right. I tend to err on the side of caution though, which may be obvious. Other options to consider would be turning it into a builtin workspace or entertainment unit. Ex.

Euro-Chic · More Info

A cheaper option would be to remove the mantel and install a standalone toy box in the lower nook for a few toys, blankets, games. You'll have to add trim where the mantel met the floor if you remove it. I thought you could use the trim from the back of the nook since it matches perfectly and will eventually be covered. A toy box could then hide the missing trim.