Hello all and thanks in advance for the help.
The details:
2001 Discovery II with about 67,000 miles on it. No codes are thrown. Less than 1,000 miles ago did ALL major service including all the fluids with proper grade Royal Purple synthetics. I rebuilt the front driveshaft prior to any problems and it is in excellent condition. The rear drive shaft is also in perfect shape.
When I shift into reverse or any forward gear, there is a grinding noise as if a shaft is spinning inside a gear. Think of a baseball card in the spokes of a bicycle when we were kids. There is no engagement of the tranny though and no power getting to the transfer case.
My troubleshooting: I check the driveshafts, both good. I shifted the the transfer into both high and low gears. Same noise. I shifted the transfer case into neutral. Same noise. I drained the transfer case and opened the inspection plate (No metal at all in the oil. actually it was crystal clear.) and had my wife start the truck and shift it into gear. There was absolutely no movement of any of the gears. With the truck off, I had my wife roll the truck backwards a few inches and saw the T case gears move properly with no binding. The tranny fluid level was good. Drained the tranny and the fluid was also clean with no burn smell and there was no sludge nor metal in the fluid or on the drain plug. I filtered the used fluid through a clean paper towel just to be sure.

One more note: I had driven the truck the entire day prior and parked it in the driveway. No codes, unusual puddles, smells, etc. When I jumped in it the next day, the problem happened immediately and I never left the driveway.

Another note: I did not keep the tranny in gear for any length of time. Just a few seconds each time I was trying to track down the issue.

I popped off the torque converter inspection cove, but have not had a chance to really give it a good inspection. Nothing fell out when I took it off though.

Thanks again everyone!

 

You missed the problem. Start your engine, put the tranny in gear with the e-brake on and crawl down and look at both drive shafts, the one that is spinning is hooked to a diff that has blow, broken axle or cv joint.

 

Thanks for chiming in Mike. Neither drive shaft is spinning. Also, when I roll the truck backwards in neutral, both driveshafts do turn and there is no noise whatsoever from either diff. I have blown diffs on other trucks before and have always had some kind of symptom. Usually weak diffs with oversized tires and abusive driving. This truck has stock everything and is gently driven.
I rebuilt the front driveshaft recently and it is still in perfect shape. I took it out yesterday just to verify. At the same time I locked the transfer case and tried shifting into gear and still same problem. I unlocked the T case, reinstalled front drive shaft and still no dice.