If anyone thinks this is salvageable, by all means don't be shy. Otherwise, I guess I'm on the hunt. The last core I could find with a quick search had Crushers selling a few seized and unseized engines last year. Not sure what is left of those and if it's worth the money/risk, or if I'm really just better off trying to source something that runs from Australia. Those seem to hover between 2k AUD and 5k AUD plus shipping, which I hear is anywhere from 500-1000. Honestly, at this point I'm guessing that to replicate my previous work (assuming a useable core for 1500 at my door) would put me around 4500-5000 with machining and parts. Seems like a replacement could be the better deal...
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I do not think it is salvageable. First, you are already .5 over. You could go to 1 over, but will need it bored, honed, new pistons, rings...lots of work and expensive. And that still does not address your problem, and you'll still not know whether some internal blockage will cause the exact same thing once you are done with the engine.
It reminds me very much of the cursed 1HDT I had. That engine was fully rebuilt, but never ran right and vibrated a lot. Then it burned pistons 5 and 6. We rebuilt it fully again, then the head cracked, and we put a brand new head on. Then ist started to mix oil and coolant. At that point I had enough and threw it out-there was likely some internal damage that was impossible to see. You are in a similar boat.
I agree that you should either get a new or (proven) good short block, and swap your good stuff over. If you can get a good 1HDT, perfect, otherwise go for the 1HZ. The blocks are identical with the only difference being the turbo oil supply and drain being there and a boss being tapped for the turbo stay.
Your pistons are probably good, but the 05 over won't help you, likely.
Good luck,
Jan