There is a strong interest in developing environmentally friendly synthesis approaches for making polyurethane elastomers (PUE) with desirable mechanical performance and flame retardancy suitable for a variety of applications. Hence, in this study, a novel nano functionalized lignin nanoparticle (Nano-FL) containing nitrogen (N) and phosphorus (P) moieties was developed via mild grafting reactions combined with the ultrasound method. The Nano-FL incorporated in the PUE acted as both crosslinking agents and flame retardants. The novel Nano-FL showed good compatibility and dispersibility in the PUE matrix, thereby overcoming the weakening effect of adding traditional lignin flame retardants on the mechanical properties of the PUE materials. PUE/Nano-FL exhibited strong tensile properties. Compared with control neat PUE, with 10 wt% of Nano-FL addition, the PUE attained a limiting oxygen index as high as 29.8% and it also passed the UL-94 V-0 rating. Furthermore, Cone Calorimetry Test (CCT) showed that the addition of Nano-FL not only reduced the heat release rate and the total heat release but also decreased the total smoke production rate during combustion. The char residues of PUEs with Nano-FL showed a high oxidation resistance with dense and continuous structural morphologies. The combined barrier and quenching effects of the char layer provided excellent flame retardancy performance. The novel Nano-FL developed in this study showed excellent promises as green functional additives for enhancing mechanical, thermal and flame retardancy performance of a wide range of polymers.