22RE compression ?
 

When I rotate the motor with the oil pan off air comes out of #3 cylinder from the bottom. The spark plugs are all in. What could it be?

Some air leaking down is normal.. But it shouldn't be a lot.
There's a test for this sort of thing, it's called a leak down test.

It's most likely rings.

Broken rings. A little is okay but not to much. I pulled apart my 88 22re with 300k mi on it as it was leaking by really bad. Every ring on every piston was broken. #4 rings were in little pieces but still in place. Was running good to. I would just drive it till it craps out. You will have to rebuild it all anyway.