I think you'll find that a lot of that crud is a scale build up rather than actual rust.
I suggest you have 2 choices.
Either, give it a going over with a wire brush to remove the bulk of it, and then build the engine.
Or, get it bead blasted back to bare metal, and apply special paint designed for the inside of engine blocks. I can't tell you what that paint is, 'cos I've never used it, but I've seen it, usually brown or orange.
I've always taken the first option, and never had a problem. If you maintain a good level of anti corrosive coolant mix it will prevent any future deterioration.
The reason why old engines look like this, is 'cos until the '70s people paid very little attention to coolant mixes, specially to the anti corrosive properties of them.
It was with the more widespread use of alloy heads, then blocks, that corrosion became something needing preventative action.