The purpose of the flight was to provide dual instruction to a rated single-engine-land pilot in basic float plane training. After practicing a number of landings, the instructor (IP) simulated an engine-out by reducing the power to 1000-1200 RPM. At this time the aircraft was on a close-in downwind leg beside the lake. The IP realized the student would not be able to land on the lake without adding power. He told the student to add power and then took the controls. The aircraft continued to sink and the floats struck the tops of several trees while on a short base leg. The IP visually checked the floats and saw no damage, but did notice the plane was carrying some branches. He made a controlled landing in the water and then headed for the shore. By the time they got to the shore, the damaged float rigging allowed the plane to lean to the right with the right wing dragging in the water.