Well crap! Advice needed with shot engine

[finaltable]

I am not trying to make money on this car. I paid 2K for it, well below market because the owner was leaving the country and wanted to get rid of it quickly. I got it in stock configuration and it is still in stock configuration. Right now, however, it has a rod knocking so anybody looking to buy this car is going to know going in that it needs some serious work from the get go.

My options are:
1. Put a new engine in it so I can sell it for something nearer to what I paid
2. Sell it as is, taking a huge hit for the engine problem.

What I really don't know is what a person looking for a Mk III would pay for the car as it is right now. If it is worth 2K with a working engine but only $500 with a messed up engine then even putting $1K toward the car is worth it.

As part of my considerations, a friend of the family restores cars and will do the swap so labor will be negligible. Most of the cost will be the engine itself if I go that route.