I have 2 DCs (3 1/2 and 21 months) - and one on the way - so my system may go out of the window then!!
DC1 has a bigish room so they play a lot in there - has nice big shelves and a big toy box. Jigsaws, books, nice toys etc are on the shelves. Bits go in the box. Separate bags/large boxes for things like lego, brio and 'sets' of things. Have got a couple of these storage things from IKEA or similar.
DC2 has a small room so plays in DC1s room but has 'own' toys on some shelves/in a box in their own room.
I have a big wooden toy box downstairs and downstairs things get flung in there at the end of the day. Don't really like having toys underfoot after DCs are in bed.
Every week or so I take all toys upstairs and put them away properly. Try and get the DCs to 'help' with this in the hope that they will learn to do this themselves. God knows if that theory will work out! Then the toys they have downstairs (where they play a lot) varies as they bring different things down from week to week.
Every couple of months I have a real sort out of the boxes that hold all the random bits. If anything is broken or has loads of bits missing then I get rid of it, though this hardly happens.
After DC3 (my last!) is born I will just get rid of things as he/she grows out of them - will pass onto other friends/charity shops/hospital or something. Otherwise we will be snowed under!
I think that I am anal though