Sharepoint - How to make a filtered lookup field

In addition to your "Deactivated" field, create a Calculated field named "ActiveTitle" (or whatever you want to call it). Use the following formula:

=IF(Deactivated,"",Title)

The ActiveTitle field will be empty when the Deactivated field is set. When you configure your lookup column, tell it to use the value from ActiveTitle instead of Title. Empty values will not show up in your lookup list, so you will end up with only the values that are not Deactivated. Let me know if you have any trouble.

Codeplex - SharePoint Filtered Lookup Field

This project creates a custom SharePoint lookup field that offers new functionalities to default SharePoint lookup field by allowing filters to be applied to retrieved data. Applied filters can be either dynamic CAML queries or pre-defined list views residing in source lists

http://filteredlookup.codeplex.com/

or for 2010

http://sp2010filteredlookup.codeplex.com/

Re the problem raised by lwbecker2, so long as you have an additional lookup column that is based on the full lookup list (ie not the 'filtered' column) then you will be able to still see the original department in the linked list.

For example, Department linking to the column ActiveTitle will be blank but Department:Title will still have the original title. Simply create a view that displays the full lookup column.