Even before 1.2, this was fixed so that blocks no longer take the space of water.  They simply 'hold' the water.  This means you can no longer eliminate pools of water by burying them, which means more work for Hellivator Diggers.  

What you **can** do is create a side-shaft to drain the water into.  If you're dealing with a large pool, you may want to build walls on either side to block out most of the water.  Then, just build a shaft long enough to contain the rest of the water and let it flow in.  Wall it up and keep digging your downward shaft.

If it's a relatively shallow pool though, just dig a trench near the bottom to drain it away from your shaft, then continue construction.  


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As a side-note for future development, you will eventually run into LAVA, which is even more difficult to deal with.  However, the principle is mostly the same, but for safety, you will have to dig around the pool and dig out your trench beforehand, then dig to the other side of your trench so that you can safely break it open and drain the lava in(though if you have a lavaskin potion, it becomes easier to use the previous method).