Yikes. At least the mystery has been solved.

Dude that sucks.

VW tdi - do it up man...

Good work so far.
Take some carb cleaner and try to get off all the carbon.
And, then post the cleaned up pictures.

All you will need are head gaskets hopefully.

Of course everyone will say take the head to the shop to get them checked..

I just cleaned the heads and put them back on.
But as your situation looks more severe, probably best to get your heads checked.

I had a crack in my head gasket - same place roughly.

looks like you are going to need a lot more than just head gaskets, it look by the pix like you had a leak behind the liner. time for a used motor.

Looks like a liner issue. Not sure if top-hat liners would fix that, but a used motor is probably cheaper. There are plenty around that only need head gaskets.

You can't tell from the pics but there is a hole in the liner and a lot of material missing from where the hole in the liner is and the crack in the block. Also there is a chunk missing from the piston. Any how I found a used motor with 112k out of a wreck which I'll probably be picking up this week. Any tips on removing the old engine and dropping the new one in.

the only thing that is difficult is reaching the bolts on the top rear of the motor,
if you unbolt the motor mounts the engine will drop forward enough to give you room to get to them.

I appreciate all of the helpful info. Are there any special tools I should pick up to make the job easier.

to pull the motor; No standard socket and combo wrench set.