Don't touch it. Don't do anything more to it.
Put it in the back of your truck, along with everything you took off of it, and bring it back to the shop that sold it to you, bring one of your larger buddies with you (or one of your wife's larger relatives, or rent an off-duty cop for "security" – NJ cops will work for food), bring the seller around and show it to him. Have your phone recorder on, but not obvious.
If he doesn't immediately say, "Crap, I had no idea, I'll [do something satisfactory]" then get him to acknowledge that he sold you an ostensibly working engine for $800, then use the recording in small claims court to get your money back, plus treble damages (as he is a business and sold goods fraudulently).
Don't put it off. You need to act as soon as you realize there is a problem.
And don't warn him, just show up.
disclaimer: I am not an attorney.
– Eric
edit: Not trying to push you into something, small claims court is a giant PIA, and collecting through the sheriff even moreso, and it may not be worth the $800 to you. That's fair, too.