Rare earth doped nanoparticles with sub-wavelength size can be coupled to optical micro- or nano-cavities to enable efficient single ion readout and control, a key requirement for quantum processors and high-fidelity single-ion quantum memories. However, producing small nanoparticles with good dispersion and exploitable optical coherence properties, another key aspect for these applications, is highly challenging by most synthesis and nano-fabrication methods. We report here on the wet chemical etching of Eu3+:Y2O3 nanoparticles and demonstrate that a controlled size reduction down to 150 nm, well below the wavelength of interest, 580 nm, can be achieved. The etching mechanism is found to proceed by reaction with grain boundaries and isolated grains, based on obtained particles size, morphology and polycrystalline structure. Furthermore, this method allows maintaining long optical coherence lifetimes (T2): the 12.5 μs and 9.3 μs values obtained for 430 nm initial particles and 150 nm etched particles respectively, revealing a broadening of only 10 kHz after etching. These values are the longest T2 values reported for any nanoparticles, opening the way to new rare-earth based nanoscale quantum technologies.