You're best bet would be to rear mount the engine on a parcel rack. Get a special motorized bike sprocket to fit on the rear left of the tyre. You only need one gear if you have a fairly large sprocket on the tyre. Pedal to start then drop the clutch and away you go! Check out MotoredBikes.com...
You should be ok as long as you "ride under the radar". If you want more info check out MotoredBikes.com: Motorized Bicycle Forum - Gas & Electric Bikes
Sounds like your exhaust gasket is blown. For tips and techniques with motorized bikes check out the forum MotoredBikes.com: Motorized Bicycle Forum - Gas & Electric Bikes
You could try an engine kit designed for a bike. Have a look at the motorized bike forum for some ideas MotoredBikes.com: Motorized Bicycle Forum - Gas & Electric Bikes
You just need a frame that will fit the engine that you are trying to install. You can pedal without the engine running yes! For more help check out the motorized bike forum here: MotoredBikes.com: Motorized Bicycle Forum - Gas & Electric Bikes