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If you can find new coils, I would personally replace them so that they do not cause any hassle in the future, especially for a racing motor that you will likely be using often, but cleaning the contacts (and probably replacing the condensers) would be a good start if this is not the path you want to take. I don’t know anything about the KG-7 racing low unit, as I have only had one KE-7 that has given me a ton of unidentifiable (to me) trouble, but if the lower unit is similar there may be a screw by the bolt to remove the lower unit from the tower that you can pump grease from the bottom to the top until all of the old grease is out, but I do not imagine that is the same on the racing LU. If your test tank is big enough, I would put a propeller on so that you can better get a sense of how it pumps water with the propeller on, and yes, I would use fresh fuel. That is just my uneducated opinion, but I wish you well with this motor, and hope that it has enough might to put the midget flyer well past 35.
"Outboards seem to multiply exponentially..........I find that for every finished project, there are two more waiting to be completed."