I found a thread on TechNet about the issue and the OP (original poster) replied saying that it was a bug all along and it had been patched.
Well as I wrote on the TechNet thread, I am still having this issue on a fully patched 2012 R2 Standard server. I was able to work around it by using the local Administrator account to assign permissions, rather than using an account in “Domain Admins”.
This bug does not seem effect permissions when using the folders, as I am able to create/modify/etc.; it is only an issue when setting the permissions on the folder.
Here was my folder when logged on as user1, a member of Domain Admins:
As you can see, Domain Admins have “Full control” of this folder and should be able to set any permissions needed. But I kept getting the error in the screenshot at the beginning of this post.
After reading the thread I found on TechNet, I logged on as the local Administrator, went to the folder in question, and added the group I wanted to have access. I then made those permissions propagate to all subfolders and it went quickly and without error. So it works as local Administrator but not as a Domain Admin.
From what I can tell the issue is that Windows Server 2012 R2 cannot recognize that user1 has “Full control” of the folder because user1 is not listed explicitly in the ACL. Even though user1 is a member of “Domain Admins” who are in the ACL, it does not matter.
This seems like a bug to me, but at least there is a fairly easy workaround.