Thanks for the comments guys.
- I did not do another compression test after re-assembly quicksandfarmer...other than curiosity I can't see a reason to, did you have something in mind?
- Air in the fuel lines...this is the simple kind of thing that I'm worried I'm missing.
Some of the most vexing problems can happen where there are multiple things wrong. We've already seen that in this case, where clearly there were issues with the cylinder head, but things beyond that.
In terms of the blow-by, in the words of Bernie Madoff, "there is no innocent explanation." There had been some possibility that leakage in the cylinder head was causing it, but with the work you've done I think you can say conclusively that either one or more pistons, or the engine block itself, is bypassing. So now you have to make two decisions:
1. Whether to repair the tractor or get rid of it.
2. If you decide to repair it, whether to repair the engine or replace it.
Ultimately, it's going to be your decision. Here's the thought process I would go through: You can buy a brand new 254 for about $8,000. I'm going to take a wild guess and say that in good used condition one is worth half of that, or $4,000. When all is said and done it could cost $4K in parts and labor to get your tractor running, so from an economic perspective it has little value beyond what the local scrap yard is paying per ton. I may be way off, you can test that by posting an add on Craigslist to gauge the interest, it's anonymous and there's no obligation to sell if you list something.
There are a couple of reasons to go the repair route. You have the tractor already. If you are able to do the repair more cheaply you are essentially paying yourself. If you have to pay someone else, or if you have high-paying work that you're turning away to tinker with your tractor, it's probably not worth it, but if the alternative is watching a rerun of "Star Search" it is. We're all here because we like tinkering with our tractors, so you probably won't find much support for cutting and running from us.
In terms of the repair/replace decision for the engine, that's really determined by how bad things are inside the engine. It's entirely possible that there is just one cylinder blowing by, and a new set of rings and a sleeve fixes everything for less than $100. At the other end of the spectrum, you could open the engine up and find it's a basket case, the pistons, bearings, crankshaft and camshaft are all damaged, the block is ruined, a new engine is your only hope. (Based on your description of the head the second case sounds more likely but you never know.) But here's the thing: either way, you start off by doing the same thing, splitting the tractor, and that's the real work. Once the tractor is split it might take you another hour to get the bottom off and see if you've got anything worth saving.
If I decided to go the tractor repair route, what I would do is split the tractor as if I were going down the engine repair route, and take the engine apart until I had determined exactly what needed to be repaired. Then I would price all the parts needed before deciding whether to repair or replace the engine. If you replace the engine, there is also the mitigating factor that you will have some usable spare parts from the old one.
