The influence of the nanosized rare earth (RE) containing precipitates on grain refinement during severe plastic deformation is investigated in detail through a study of high pressure torsion (HPT) processing of a solution treated and aged Mg-8.2Gd-3.8Y-1.0Zn-0.4Zr (wt%). In the early stages of HPT deformation, dislocation generation and pile-up is promoted by the nanosized RE containing β′ precipitates. With increasing strain, the precipitates are cut by the moving dislocations and gradually dissolve into the α-Mg matrix aided by dislocations serving as diffusion channels for solute atoms. After HPT for 2 turns, the hardness reaches a maximum and on further deformation the hardness decreases although the microstructure refinement continues and the dislocation density is increasing. This is due to the continuing dissolution of precipitates, which dominates the hardness evolution at this stage. After HPT for 16 turns, the precipitates have almost completely dissolved and the average grain size is ~33 nm, which is the smallest ever reported for a Mg- or Al-based alloy. The present peak-aged Mg-8.2Gd-3.8Y-1.0Zn-0.4Zr (wt%) alloy exhibits quite different microstructure evolution and hardening behaviour during HPT processing as compared to both the cast and the solutionized Mg-Gd-Y-Zn-Zr alloy.