I found this a nightmare too, but have finally resigned to a system where I have some large, thick plastic bags, which are the sort you get from ELC with tigers or crocodiles on for doing sack races - really huge - I have two of these. One has the 2-3 year old stuff, one has 4-5 years.
The 1 - 2 year stuff is already partly in use so is stored in a separate bag in my room, where I keep the boys' chest of drawers. Ready to be ransacked when he is slightly bigger!
This is a disadvantage of a large age gap - mine are four years apart.
However I did find the rate of clothes and also rate of growth slows down once they are around four or five - my elder one would get through clothes rather than grow out of them, so I'm not throwing away a lot of his old stuff, as it is wrecked!
Ds2 has worn nearly all hand me downs though so defnitely worth doing. In fact we still have too much really.
I just sorted out everything and chucked the stained stuff and the stuff no baby could ever wear comfortably
They have two drawers each in my room for their current clothes. I find sorting it all in one room much easier!
Shoes go under the bed until they grow out of the current 'range' and then I swap them over. (yes, I save shoes )