Navigate to the Avitars Configuration (CP -> Membership -> Profile Settings -> Avitars Tab) and select the optons you wish to have enabled:

• Allow Remote Avatars? - Do you want users to be able to link to avitars from "off-site" locations (their own site, other peoples sites, free image hosts, etc)?
• Allow Stock Avatars? - Do you want users to be able to utilize the "pre-installed" avitars on your server (Generally located in image/avitars/)?
• Allow Uploaded Avatars? Do you want users to be able to upload avitars (see below)?

You'll also have several options on this page to further customize the avitars system. One of which is the "Uploaded Avitars" options:

• Avatar Upload Storage Directory - This is the directory on the server (full server path) to where you're allowing these images to be uploaded (such as /home/yoursite.tld/public_html/forum/uploads/)
• Full URL to Avatar Upload Storage Directory - This is the full "web url" to the aforementioned upload directory (such as http://www.yoursite.tld/forum/uploads/)
• Maximum file size of uploaded avatars - This is the max amount (in bytes) that you wish for users to be able to upload. Please note that you generally don't want this to be too large (I personally would recommend nothing larger than 25k-50k (25600-51200 bytes) for a measly avitar).

There are also "max size" definitions, which allow you to set a maximum size of the images.

From a user side, they'll need to visit "My Stuff -> My Profile" and then at the bottom of the page they'll see the Avitar's section, from here they'll have several options (based on what you enabled above); they'll be able to drop a URL in for a remote avitar, select a stock avitar from your server, upload a new one, or use no avitar at all.