The invention provides a magnesium modified ultrastable rare earth Y-type molecular sieve and a preparation method thereof. The method is as below: conducting a rare earth exchange reaction and dispersion pre-exchange on a raw material NaY molecular sieve; then conducting superstable roasting treatment; and finally conducting magnesium modification. The molecular sieve contains 0.5-5 wt% of magnesium oxide, 1-20 wt% of rare earth oxide, and no more than 1.2 wt% of sodium oxide, and has crystallinity of 46-63% and lattice parameter of 2.454nm-2.471nm. Compared with the prior art, the molecular sieve prepared by the method has rare earth ions located in a sodalite cage, which shows in that no rare earth ion loses in the exchange process; at the same time, molecular sieve prepared by the method has particle size D (v, 0.5) no higher than 3.0 mum, and D (V, 0.9) no higher than 20 mum. The molecular sieve has high stability and objective product selectivity, can be used as active component of a catalytic cracking catalyst, and has the characteristics of high heavy oil conversion capacity and high yield of the objective products.