Carbon-encapsulated magnetic nanoparticles are promising candidate materials for drug-delivery applications. However, due to their hydrophobic and aggregation properties, which indicate lower biocompatibility, proper surface modification of the carbon-based material is required. In the present study, we present the facile route to producing biocompatible magnetic nanocomposite iron oxide/carbon using the liquid medium arc-discharge method. The medium used was ethanol 50% with urea added in various concentrations. Using x-ray diffraction (XRD), the nanocomposite produced was confirmed to have a crystalline structure with distinctive peaks representing iron oxide, graphite, and urea. Fourier transform infrared spectroscopy (FTIR) analysis of the nanocomposite produced in ethanol/acetic acid or ethanol/urea medium shows several vibrations, including Fe–O, C–H, C–O, C=C, C–H, O–H, and C–N, which are intended to be the attached aromatic oxygen- and amine-containing functional groups. The nanocomposite particle was observed to have a core–shell structure that had an iron-compound core coated in a carbon shell possibly modified by polymeric urea groups. The presence of these groups suggested that the nanocomposite would be biocompatible with biological entities in the living body. Lastly, the prepared nanocomposite Fe3O4/C-urea underwent an in-vivo acute toxicity assay to confirm its toxicity. The highest dose of 2000 mg kg−1 BW in this study caused no deaths in the test animals even though cell damages were observed, especially in the liver. This highest dose is considered a maximum tolerable dose and is defined as practically non-toxic.