The problem with the ATMega8 Arduino bootloader is that when it is compiled it goes larger than the 1k limit, so to solve this if you are using the AVR Studio 4 go to Project > Configuration options and in the last tab at the bottom, Custom options add "-finline-limit=1" without the quotes, and you're good to go, this will limit the 1024b and will fit in the ATMega8.

Here is another tutorial about the latest bootloader the Optiboot