The effect of yttrium addition and heat treatment on the mechanical properties and microstructure of AM60 magnesium alloy have been investigated using X-ray phase analysis, microstructure investigation, tensile test, hardness measurement and fracture surfaces analysis. The results showed that the mechanical properties of the alloys were obviously improved with the addition of yttrium no more than 1.0%. The reinforcement of the alloys resulted from the appearance of Al2Y phase. After solid-solution treatment (T4), the Mg17Al12 phase almost dissolved in Mg matrix, but the rare earth compounds Al2Y phase was rather stable. The ultimate tensile strength σb was improved, but the yield strength σ0.2 and elongation δ were only slightly changed. After solid-solution + aging treatment (T6), the Mg17Al12 phase precipitated again and their morphology was changed. The yield strength σ0.2 was improved.