Nitrous oxide (N2O) is an industrial waste gas (e.g., from the production of adipic acid), which damages the ozone layer and causes the greenhouse effect. Density functional theory calculations were employed to investigate the mechanism of direct catalytic decomposition of N2O and selective catalytic reduction (SCR) of N2O by CO over Fe-ZSM-5 zeolites. Two stable Fe-active sites with six-membered ring structures on Fe-ZSM-5 were considered. The calculations indicate that the decomposition of N2O is affected by the coordination environment around Fe and can occur through two reaction pathways. However, there is invariably a more considerable energy hurdle for the initiation of the second stage of N2O decomposition. When CO participated in the reaction, it showed good reactivity and stability, the reaction energy barriers of the rate-limiting step were reduced by roughly 20.57 kcal/mol compared to the direct catalytic decomposition of N2O. CO exhibited a superior electron-donating ability and orbital hybridization performance during the reaction, which enhanced the cyclicity of the N2O reduction catalytic process. Our calculations confirmed the significant role of CO in N2O reduction over Fe-ZSM-5 observed in previous studies. This study provides a valuable theoretical reference for exploring CO-SCR methods for N2O reduction over Fe-based zeolite catalysts.