Sorry, I probably cannot offer much help, but can try. First, how many miles are on the transmission? I almost bought a 1986 560SEL and it had transmission problems an I know of another guy with a 1989 560SEL locally that is for sale with a bad tranny (ironically, he also has a 1989 BMW 735IL with a bad transmission). I do not know if transmission issues were widespread issues on these V8 W126 cars or not, but seems to me that I have read of more problems on these than I have other MBs, at least on the 1986-91 models, but does not seem as much so on the 1981-85 V8 W126 models. I had a 1985 380SE with 275K on the original tranny and aside from a harsh shift into reverse, the transmission otherwise shifted perfectly and smoothly... no flaring, slipping, etc. Just smooth and shifted right on time - much like the transmission on my 1988 300SEL (which may have the same transmission as your 1986 560SEL? I am not sure).

I would first try to have the fluid AND filter changed (use genuine MB fluid) before I proceed with a rebuild. Also rather than a dealer or a shop that works on all cars, I would try to find a little independent shop that specializes in Mercedes, or at least German cars in general.

What about when you shift into reserve or drive? Does it engage quickly and/or does it slam into gear?

I would not think the worst yet... as it could be something simple... something as simple as a valve, solenoid, vacuum line, etc... ??