I'd do colorful carpet squares wall to wall -- would define a play area (no toys off the rug at end of day!) and the squares are easy to clean and/or replace in case of a stain.

Beyond that, just lots of stuff down at short people level -- bins for toys, cushions for lounging, maybe a low bookcase. I like the idea of chalkboard doors, and you could use those lower cupboards for kid stuff too. Probably the higher shelves will need to be for adult stuff for some time yet -- you could put Read Aloud books up there, or wipes or other supplies... A low table for scribbling could be good -- we had one with folding legs that could be stowed if more floor space was needed for other things.

Love the square carpet idea! Thanks for the awesome ideas!

Caution on the chalkboard doors! Little ones do not discern well, better to have a regular wall mounted board..."The chalk goes here and nowhere else".

I might paint the back of the bookcases but I would leave the rest of the builtin as is.

I'd add a larger rug - something modern and playful. Add a round table and chairs for crafts and maybe some round poufs or floor pillows to create a reading nook. See below for some inspiration images. Good luck!

There's nothing like great comfy seating where kids can lol about and adults can enjoy themselves too.