A new method termed plasma-assisted etching (PaE) is introduced for the ultra-smooth finishing of single-crystal lutetium oxide. The feasibility of atmospheric pressure plasma modification is demonstrated through a quantum chemistry simulation, where the energy of the plasma modification reaction is −28.848 kcal/mol and the energy of the barrier is 14.377 kcal/mol. The irradiation of helium-based hydrogen (circa 0.5%) plasma with a flow rate of 2 L/min efficiently serves to modify the surface of single-crystal lutetium oxide into hydroxide at a rate of 320 nm/h. The experimental study shows that PaE using 25% sulfuric acid as the etchant can remove the modified layer of the lutetium oxide wafer without inducing crystallographic subsurface damage. The experimental results show that a scratch-free atomically flat surface with a surface roughness of 0.45 nm is achieved using this new approach.