Well lets see, I will throw in my two cents here since I have been playing with my CJ-7 for about four years now.
Interestingly enough, if yours is a 86, you had a shot to have a factory Dana 44 rear since a lot of the latter 86 models left the factory with one. You have a Model 20 rear which you will hear a lot of opinions on. I still use the Model 20 in my Jeep, but the first thing you want to do is upgrade the axles to a one piece design. You can find the kits from Superior or Moser.
Now a lot of people will tell you just put a stronger axle in there from another vehicle such as Dana 44 from a Wagoneer. This is good advice. I did not go that way but I have had zero problems with my Model 20 and I wheel pretty hard. That choice is up to you, but you have to take a care of your original axles right away or you will break on the trail and ruin your day!
Next, you will probably want to think about lockers. Again there many ways to go. I use Detroit lockers front and rear and I love them. They are strong and moderately priced. If you have a unlimited budget, go for ARB air lockers which are selectable, which means you can turn them on and off at will, (nice option when you need to turn a tight corner on slickrock). I firmly believe that differential lockers are the single most important upgrade you can do on a wheeling Jeep!
I assume you have a inline 6 engine which is a great motor. If it is running well then you do not need to do much to it as far as upgrading. You probably have a T-176 tranny if you have a standard tranny. That is a good strong transmission and will give you little problems. You also have a Dana 300 transfer case which is also a strong performer and will usually last a good long time. One upgrade for the t-case which I like is the Tera-low gear set. It gives you a 4-1 ratio as opposed to the 2.62-1 that comes stock. Good strong low gearing is a must for the Utah trails like the snakes and Moab and such.
As far as lifts go I recommend the Rubicon Express 4.5" Extreme Duty lift. It is pricey but well worth the money. It gives YJ width springs in the front with greasable shackles. It also includes many other neccessary items. It does not come with shocks however and those can be discussed later. You should be able to fit 35" tires under this lift with little problems. You will however need to lower the t-case about 1" to prevent rear driveline vibration. I believe th R.E. kit does come with the t-case lowering kit.
Depending on the size of tires you choose (I have 35 inch Goodyear MTR's) you will need to go to a lower gear ratio (higher number) in your differentials. I have 4.10's in mine and they work well, 4.56's would be a good choice if you have the 6 cylinder motor instead of the V8 that I have. If you go 33" 4.10's would be good, 35" go with 4.56.
Well that about covers the basic, first do upgrades for a CJ-7. Keep in mind that this stuff is not cheap and will rarely increase the "value" of your Jeep, but if you want to wheel and have confidence doing it then you have to spend the money.