we affectionately call our area "dress up land"-- have for years.
We weed out torn/dingy stuff but usually keep everything else. I used to think that life would be better with less dress up, but my oldest (very into acting) still plays with this stuff (turns 11 this month). We have enough so that different plays can be produced with costumes at home. We have stuff that would be for male roles as well. We also have lots of hat, scarves, jewery, and shoes. We don't add to the collection anymore, so it seems to remain stable--if someone in the family goes on a trip, they usually pick up something that would go to dress up land. . . and by that time, something else is usually torn or dingy.
We use a corner of the play room for our dress up land. On both walls, we have a row of hooks--one wall as a set of 4 double hooks, the other wall has 6 hooks. (Even three year olds can put stuff on hooks). Below that, we have two fairly large clear OPEN bins for accessories/shoes/hats/scarves. We have one small bucket for jewelry. So, what can be put on the hooks IS put on the hooks. . . everything else is tossed in a bin. Sometimes the girls try to put shoes and hats in one bin and scarves/purses/misc. in another. I don't care about that--just so that the stuff remains contained. If we would have created this space with our kids at their current ages, I would have added a row of hooks above the current rows of hooks. This would have been for the hats--some don't fair so well in bins. I would have also added higher hooks for the necklaces, etc. But, with only little kids at the time--they would have had a hard time reaching up very high. I also think that a shelf above the hooks would have been useful. But anyhow, our system works really well. Sure the dresses sometimes drag into the bins, or the bins are pushed into the dresses, but that is ok. We provide a true "costume closet" for all their imaginative play. And, it really doesn't take up much space.
We even had a birthday party once where the kids came in, got their nails and makeup on, then went down to dress up land and got all "decked out". They then put on a "fashion show". It was tremendous fun.
Oh, btw use HOOKS not pegs. The hooks curve upwards a bit so that clothes don't fall off, where as rows of pegs usually have the clothes underneath in a pile (esp. if young children are trying to do the hanging!). Don't get stuck thinking that only one item/hook. Also, if you have a bunch of skirts (and really young kids), sew little loops on the waistbands that can easily slip onto the hooks.