Well, perhaps it is just the vertical neutral lock out bar that rides on the shift lever. Does it move back and forth freely? The throttle has to be retarded in order to shift the gears.
My next suggestion would be to remove the gearcase in an effort to determine whether the gearcase linkage is stuck/damaged, or the shift linkage on the engine is jammed up. Sounds like the gearcase needs to be pressure tested to determine the source of the water leak anyway..
