I love doing this kind of thing, both as a player and as a DM.
Generally, I don't give or expect much XP from down-time stuff, the reward in my mind is having a more direct hand in deciding how the character develops. Sometimes, though, giving a bonus level is OK, especially if the campaign has been tough, or is about to become a lot tougher.
Of course, there are dangers to giving players this much freedom to tell their own sotries...one of my favorite episodes of "down-time" that I've been involved in was a 2E D&D game I was in a few years back (just prior to 3E). The party was told after a major story arc ended that a year passes in game, and to describe what we've been up to. I had a lyre of building, that had been pretty much forgotten about by the rest of the group. In the course of events, a city had been laid to waste by big bad supernatural beasties, so I went there and rebuilt it. Set myself up as guildmaster of a merchant's guild and a thieves' guild, built an academy as a front to train potential followers/henchmen, and opened up trade with nearby dwarves and hill giants (both of which we had befriended). The DM had never even considered anything like this happening, so he ran with it. I ended my year off by sending out invitations to the rest of the party to attend the inaugural ball at the new Stonehaven Academy. The looks on their faces when they realized what that lyre of building they threw away was cabable of was priceless...and the DM had more new story hooks than he knew what to do with.
That's the most rewarding part about "down-time" to me; when the DM lets you use it to help build up the world. It ties the players in to the campaign world a lot more, and lets the players help shape the game in the way they want to see it. I wanted more political maneuvering in that 2E game, and as the halfling Godfather of a budding mafia, I got all the politics I could handle...
(PS...through no fault of my own, my characters' criminal persona was dubbed "Mr. Big", being a halfling crime lord and all. I suppose I deserved that...)