Rusted block from tap water

This is what I love about tw. You post your question, you get several options on what to do. Now just to decide which plan to use.

My thought, do the head gasket like sep1911 suggested. If you do decide to tackle freeze plugs, I used some stuff, I think it was called 3m supertack, to seal between the freeze plug and block. It's hard to tell from the pictures, you saw an area of failure in the head gasket?