Is it really rust or varnish from dried up oil and fuel. Anyway its above the rings. I personally wouldn’t mess with it. You decide. Point can however needs to have the rust removed and made as smooth as possible. I refreshed a KF-7 with new coils, condensers, plugs, wires, impeller prop shaft seal, drive shaft seal, upper and lower crankshaft seals, and a bunch of gaskets. After 4 years of running it quite a bit, the bottom cylinder started dropping out. After 2 summers of getting nowhere I decided the Bendix mag was bad. Spent over $200.00 rounding up the pieces to a Phelon magneto. The problem was actually the new lower crankshaft seal. That may not be your problem but I recommend you change both crankshaft seals first. Here is a tip. When you put it back together, but the bearing in the freezer, and use your heat gun (1500 watt), to heat up the bearing holder and the bearing will drop right in.
A "Boathouse Repair" is one thats done without having tools or the skills to do it properly.