Sacred space is, in theory, all space - everything that exists is sacred (including what we would consider to be "empty space" or "nothingness"). However, for the purposes of magick, it refers to the space within which we perform sacred acts such as rituals and spells. It is space that you cleanse and dedicate with the specific intention of maintaining useful and helpful energy, and which you consciously separate from the "mundane." The mundane represents everything that you do outside of magick - cleaning the house, cooking, working, etc. Although all actions that we perform have the potential to be sacred (even cleaning the litter box), most of us perform many actions without being fully aware of them. If you don't believe me, consider your awareness of the room around you as you read this. Only when your attention is focused on a thing or an action can you be fully aware of it.
This is why normal activities are referred to as mundane, while magick never is. Performing magickal rites requires your full attention - not to give your full attention to what you're doing is to disrespect the beings in attendance, especially those you specifically called. So, your sacred space is the space in which you are always conscious of your actions, your thoughts, and your feelings, and your focus is in the moment. This is why sacred space is unique, and why it's especially good to keep your sacred space in the same spot. The more that stays constant each time you perform magick, the easier it will become for you to enter a meditative state at will. Anything that stimulates any of your senses can become an unconscious trigger that you are about to perform a sacred act of magick. This certainly applies to maintaining your sacred space in the same room or same area in a room, and will make it easier to enter the state of mind necessary to perform successfully (and consistently).
It is important to do several things once you have chosen a spot as your sacred space. The first is the cleanse it. This can be a somewhat abstract term, since it doesn't imply getting out the vacuum cleaner and a duster. Some witches will tell you it's to remove the "bad" energy, leaving only "good" energy. Personally, I don't make this distinction, so I think of it simply as a combination of the following:
Tidying up for guests. If you invite friends over for dinner, you don't want them coming over to a pigsty of a house. To do so would be rude and disrespectful because it implies that the guests aren't important enough to clean up for. In magick, you invite guests. You want them to be comfortable and provide a pleasant atmosphere for them.
No one works well in a cluttered environment, and this applies to spiritual, emotional, and psychic clutter as well. By removing residual energies that would hinder your magick, you're making it that much more likely to be successful and effective.
Next, you consecrate it for magickal use. By ritually consecrating your space, you are alerting your conscious and, more importantly, your unconscious minds that this space is special. Your unconscious responds to ritual and provides a great deal of power in the magickal process, so it benefits you to designate your sacred space in a manner that your unconscious will understand.
Both of these can be as simply or as complicated as you like. You can visit the Magick: Chants page or visit Lady of the Earth: Consecration and Cleansing if you'd like to use a chant or ritual that's already written. However, I'd like to stress that writing your own chants is extremely powerful because they contain your own personally energy, but if you don't feel comfortable writing it yourself then that's ok, too.
After you cleanse and consecrate your sacred space, you'll want to set up your altar.