I suggest, indeed, letting children who wish go to school in clothes of the opposite sex -- but not counseling other children to not tease them or hurt their feelings.
On the contrary, don't interfere, and let the other children ridicule the child who has lost that clear boundary between play-acting at home and the reality needs of the outside world. Maybe, in this way, the child will re-establish that necessary boundary.
It is a mistake for various interfering, ignorant, and biased busybodies to try to "counsel" the other children into accepting the abnormal. It is very healthy to be able to draw the line between what is healthy and what is sick.