The formation mechanism of α″-Fe16N2 phase was investigated in the form of nanoparticles. Both α-Fe and γ-Fe2O3 nanoparticles were used to prepare α″-Fe16N2 by using a low-temperature nitriding process (≤180 °C). The synthesized α″-Fe16N2 nanoparticles have a high α″-Fe16N2 volume ratio up to 93%, with a specific saturation magnetization of 178 emu/g (room temperature) and coercivity of 2.0 kOe. The formation of α″-Fe16N2 phase includes three stages: (1) the heterogenous nucleation of α″-Fe16N2 with simultaneous chemical reaction, (2) the growth of α″-Fe16N2 with a local electric field in the Fe16N2 layer, and (3) the termination of Fe16N2 growth due to the nucleation of other Fe–N phases (ε-Fe3N or γ′-Fe4N). In low-temperature nitriding, NH3 was used as the nitrogen source. The adsorbed NH3 molecules on the Fe surface decompose into N and H atoms, and then N atoms react with Fe and nucleation of α″-Fe16N2 simultaneously occurs at the high-energy surface sites of reduced Fe nanoparticles. The growth of α″-Fe16N2 phase can be explained by the electric field modified diffusion theory, where the electric field is established by the migration of Fe and N ions and electrons. Finally, the nucleation of Fe–N stable phases (ε-Fe3N or γ′-Fe4N) ceases the further growth of α′′-Fe16N2 layer. Then, there is critical thickness for the α″-Fe16N2 layer, which is estimated to be 10–15 nm from the surface. Therefore, single-phase α″-Fe16N2 nanoparticles are expected in fine particles with less than 30 nm in diameter.