For anyone who is still as confused as I was after reading this thread, here is a step by step as to how I handled it.
I created a user-controlled character called "Player"
I created an isometric obstacle called "Tree" in the same Layer as "Player"
Next, I edited the collision on "Player" to only collide around the character's feet.
Then I edited the collision around the "Tree" to only collide around the base of the tree.
I created a new Family called "Sprite" and added both "Player" and "Tree" to it.
I selected "Sprite" from the right-side menu and then clicked "Add / edit Family instance variable" from the left-side menu.
After clicking "Add new instance variable" from the popup, I named the variable "sortOrder" and type "Number" with the initial value of 0.
Next, I visited the Event Sheet where I added a new System action for "Every tick."
To the right of that, I added a an action where I first selected "Sprite" and then "Set Value" to "Sprite.Y"
Immediately below that, I added a new System action followed by "Sort Z Order" which asks which Object to select. I chose "Sprite" and the "sortOrder *number)" variable was already selected as the instance variable.
That's all. I clicked play and everything sorted properly. NOTE: I had to play with the collisions on both the Player and Tree object to get them to look the way I wanted.