The head might be salvageable if you have a very experienced engine builder. Beware of just shaving the head flat (which is not recommended by the VW service manual by the way), not just because it takes special head milling setup to work with the hardened prechambers, but also because the cam bores will not be aligned afterward either. So you'd need the cam bores align-bored as well, I'd think. If you just shave the head and bolt the head on, the cam bores will not be in a straight line due to the warping so the cam will be distorted and the cam bearings will live a very high friction life. Alternatively, junk the head and find a different core, or perhaps buy a brand new one (I know 4-cyl VW Diesel heads are available at reasonable cost... maybe new 5-cyls are being manufactured as well? Maybe check with the US head manufacturer, "Topline". Also check out overland parts / overseas distributing for new cylinder head source, and maybe "parts place" out of michigan as well.)
The block I agree hard to determine if it's rebuildable just by looking at the pics, but based on those I'd say the bore condition looks pretty bad, enough to think really serious about a rebuilt bottom end (unless you were *really* strapped for cash...)
The max overbore (to 77.5mm) like it seems you have already figured, will only punch the radius out by .5mm, and the pitting in the bores may be too deep to be cleaned up. I don't know about sleeving these engines or welding to recondition badly pitted area, but they seem like good questions to ask a very knowledgeable machinist.
You *might* consider getting 5 matching 79.5mm 1.9lTD pistons and having the block overbored to accept those, although I don't know if the rods would work and what it would do to piston projections. I have heard of them being installed before in a 1.6l 4-cyl diesel (making it a 1.7 liter 4-cylinder diesel.) The question is whether the rods and crank from a 1.9 liter were required or not. Going this route, I would budget in at least for a custom one-off headgasket, unless VW made some european-only factory 79.5mm 5-cylinder IDI diesel.
Cheapest option will probably be finding another block to use as a rebuildable core and keeping the stock bore sizes. Those piston tops look really clean by the way, usually they have lots of carbon all over them.
My recommendation is to remove the block from the vehicle as it's apparently no good to re-use, and find and bring it to a good machinist who really knows their VW Diesels, and ask their advice.
A good thing to ask a machinist to check their competency is whether they are experienced in planing the VW diesel head (with the hardened prechamber inserts), and also whether they are experienced in welding closed the cracks in the head between valves. You might ask others on this board for a good machinist to use in Oregon, IIRC they knew of someone who might fit that bill. If you strike out down in Oregon, I know a good machinist here in Seattle that you could call and ask questions on the phone, or use if you are willing to make that long drive. He can definitely rebuild VW Diesels properly and do some demanding jobs required to revive a bad head like what you've got.
In the meantime, keep your eyes peeled, and jump on if you can find, a good used 5-cyl TD out of a wrecked car. Good luck!