I was checking the air filter to see if I need to replace it and found water in it.  I checked the oil and it looked foamy and brown.  Looks like I have a blown gasket.  Other than replacing the gasket and the oil, what else would I need to check?  I am going to take the engine out, while it is out is there any upgrades that you recommend?  I am on a limited budget, so any upgrades need to be modest.

Drain the coolant as well.
CLEAN/flush everything very very very well.
Clean the head gasket surfaces with scotch bright pad.
Make sure when installing the head gasket that everything lines up with no holes in the block covered by the gasket. A lot of people just throw on the gasket in a rage of hurry. The head gasket doesn't get orientated correctly on the block and  the oil passage to the cam gets blocked. This will guarantee a seized cam and more than likely a new head.

With the rebuild, spend the money to get a valve job. Then their is also a cam and or headers.

*I thought I read you were rebuilding it, but after re-reading I'd agree with fuelish. or a cheap bottom end rebuild; hot tank and bearing replacement.*

I would look for a used engine, you should be able to find one around you fairly cheap, once you get antifreeze in the oil the bearings only last about six months.

before you spend any money on parts it would be worth taking the head off and checking for wear on the bores. My engine was pretty rough when I checked it so I swapped it out for a cheap 1.6.

Thanks for the advise, it sounds like it I am going to have to take to someone that has better equipment than I do.  With the 1.6 engine swap, what vehicle and year does it come from? 

If your showing water in the air filter. I'd be checking the intake manifold gasket FIRST.....Then all your vacuum lines...Second.
If its still snogged.. Either one of these aforementioned failures can result in moisture in the crank case...
I cant tell you how many Jeeps have come into my shop with (QUOTE) bad head gaskets , When in truth only needed a few hoses and a new pcv valve...Boxcar...

I would look for a used engine, you should be able to find one around you fairly cheap, once you get antifreeze in the oil the bearings only last about six months.

Huh?  So the engine that I replaced the headgasket on a few years ago, and that had the crankcase full of coolant, should have had the bearings go out long before now?  Hmm, I got the vehicle right here in the driveway and it still runs great with no bearing noise.  Oh, it had 200K on it, when I replaced the headgasket.

If your showing water in the air filter. I'd be checking the intake manifold gasket FIRST.....Then all your vacuum lines...Second.
If its still snogged.. Either one of these aforementioned failures can result in moisture in the crank case...
I cant tell you how many Jeeps have come into my shop with (QUOTE) bad head gaskets , When in truth only needed a few hoses and a new pcv valve...Boxcar...

He is right you should do a compression test as well as a leak down test to confirm before pulling the head.

You just want me to type allot. You know that there is way too many variables, not everyone is as awesome as you are and fix it the next day! trail tough has a whole barn full of take outs that used to sell for 450.00 so to me if the head needs to be rebuilt while it is off that is too me another no no putting a new head on an old engine, and who knows if the engine had water in it and it was cranked over it might of bent a rod just a little bit, If they are a master mechanic they may not be on here asking basic questions. so!