When I develop locally, I always set up a locally hosted dev name that reflects the project I'm working on. I set this up in xampp through xampp\apache\conf\extra\httpd-vhosts.conf and then also in \Windows\System32\drivers\etc\hosts.
So if I am setting up a local dev site for example.com, I would set it up as example.dev in those two files.
Short Answer: Once this is set up properly, you can simply treat this url (http://example.dev) as if it were live (rather than local) as you set up your Twitter Application.
A similar answer was given here: https://dev.twitter.com/discussions/5749
Direct Quote (emphasis added):
You can provide any valid URL with a domain name we recognize on the
application details page. OAuth 1.0a requires you to send a
oauth_callback value on the request token step of the flow and we'll
accept a dynamic locahost-based callback on that step.
This worked like a charm for me. Hope this helps.