When the seal protrudes into the reservoir it means that your fluid level has gone down. When the fluid level has gone down it usually means you have a leak somewhere or you bled your brakes and never refilled it.
As far as replacing the master cylinder, I wouldn't bother until you have replaced any worn brake pads or shoes and bled the system of any air. If your brake pedal still feels mushy then I would suggest butying a master cylinder rebuild kit for around $10 or buy a new master cylinder.
Hope this helps.
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