Love this play area over the bed, like the anti-loft bed. I think I'd leave off the first couple of steps of the ladder and make it a safer place for the older kids to play with and store their LEGO creations. (Apartment Therapy with loft bed inspiration)
Many small living room revolve around tricking the eye into making the area appear more spacious. Such strategies can transform an area that feels cramped and claustrophobic into one that feels cozy and aesthetically pleasing.