For every (sub)domain you want to server locally, add the following entry to your dnsmasq.conf:
address=/.domain/127.0.0.1
Now let your OS know, that you want to redirect requests to this domain to your local dnsmasq nameserver. Do this by creating a file "domain" in "/etc/resolvers".
/etc/resolvers/domain has the following content:
nameserver 127.0.0.1