Transfer case is a good bet for the initial fault. I suppose that due to the violent nature of the shifting problem as ddpapgagdd by yourself it may also be the root cause of the bigger problem you are now experiencing? Any way you look at it this is unfortunately an expensive fix if indeed it does involve mechanical failure of transfer case or transmission. I had what seemed to be a transfer case mechanical fault as diagnosed by BMW and they quoted me minimum $4500 for parts...turns out they were wrong and I fixed it myself by replacing the control module. The point I'm making is that by BMW standards the transfer case is costly since they replace rather than repair and by your description it certainly sounds mechanical. Hope I'm wrong...good luck.