Eu³⁺ co-doped Y₂O₃:Tb nanoparticles were prepared by the combustion method and characterized for their structural and luminescence properties as a function of annealing temperatures and relative concentration of Eu³⁺ and Tb³⁺ ions. For Y₂O₃:Eu,Tb nanoparticles annealed at 600 and 1200 ^◦C, variation in the relative intensity of excitation transitions between the ⁷F₆ ground state and low spin and high spin 4f⁷5d¹ excited states of Tb³⁺ is explained due to the combined effect of distortion around Y³⁺/Tb³⁺ in YO₆/TbO₆ polyhedra and the size of the nanoparticles. Increase in relative intensity of the 285 nm peak (spin-allowed transition denoted as peak B) with respect to the 310 nm peak (spin-forbidden transition denoted as peak A) with decrease of Tb³⁺ concentration in the Y₂O₃:Eu,Tb nanoparticles heated at 1200 ^◦C is explained based on two competing effects, namely energy transfer from Tb³⁺ to Eu³⁺ ions and quenching among the Tb3+ ions. Back energy transfer from Tb³⁺ to Eu³⁺ in these nanoparticles is found to be very poor.