^You aren't going to really know the condition of your pistons/valves/rings until the head is pulled. You could try a scope (or your mechanic could) through the spark plug holes and see if you can see any damage. Even if your block is perfectly usable you may still need a head if there are cracks between the valves or a coolant passage allowing coolant into the cylinders.
The more I think about it the better the mechanic's M54 and warranty sounds. Read the room and see if you can dicker a little bit and offer $3000 for the engine and work. $1800 for an M54 is a bit over priced. Actually,
Car-Part.com--Used Auto Parts Market has a 98,000 mile engine for $1500 in your area. I'm betting it's the motor he's going to sell you so he is asking $300 premium on that engine. Try dickering, worth a shot, but even $3400 is not terrible for an engine and replacement. Oh, and don't hold it against him for that $300 premium. He might have costs like having to pick up the engine, deliver, etc. It's very common business practice.
In the future (I know hindsight is 20/20), try to avoid buying a BMW from someone who thinks it is okay to have to add coolant every few trips. Giant red flag unless you can diagnose the problem and fix on your own. Used BMW's get real expensive, real fast, while paying someone else to work on them. Sorry for your experience, and my, now, rather obvious insight. It happens to us all... has certainly happened to me.
