Rice terraces are crucial for agriculture in China’s southern mountainous regions. Land use and land cover change (LUCC) in these areas impact hydrology, but our understanding is limited. In this study, we applied the hydrological assessment tool SWAT to a selected small watershed in the rice terrace-dense area of central Hunan province, China. This study covered four LUCC periods over the past 40 years and was simulated at annual and monthly scales. The results showed that from 1980 to 2020, the areas of paddy fields and drylands decreased by 4.19% and 5.76%, respectively, while the areas of forests and construction land increased by 1.14% and 92.48%, respectively. During the past period, LUCC led to a decrease of 1.77% and 2.49% in runoff and infiltration, respectively, and an increase of 1.03% in ET. However, the water yield remained almost unchanged, indicating that the rice terrace plays a positive role in maintaining stable watershed water yield under LUCC. The results of the sub-basin analysis indicated that the transformation of paddy fields and forests directly determines the trend of hydrological changes. Land use type had the most significant impact on the runoff of the rice-terrace watershed, with the proportions of paddy fields and forests being the most influential factors. Paddy fields significantly influenced the stability of runoff at the watershed scale, suggesting that a high paddy field ratio doesn’t ensure sustainability. This study offers valuable insights for managing small watershed terraces, land use planning, and achieving sustainable development in the watershed.