This paper describes the fabrication of AlN thin films containing iron and iron nitride particles, and the magnetic and electrical properties of such films. Fe-N-Al alloy films were deposited in Ar and $N_2$ mixtures at ambient temperature using Fe/Al composite targets in a two-facing-target DC sputtering system. X-ray diffraction results showed that the Fe-N-Al films were amorphous, and after annealing for 5 h both AlN and bcc-Fe/bct-$FeN_x$ phases appeared. Structure changes in the $FeN_x$ phases were explained in terms of occupied nitrogen atoms. Electron diffraction and transmission electron microscopy observations revealed that iron and iron nitride particles were randomly dispersed in annealed AlN films. The grain size of magnetic particles ranged from 5 to 20 nm in diameter depending on annealing conditions. The saturation magnetization as a function of the annealing time for the $Fe_{55}N_{20}Al_{25}$ films when annealed at 573, 773 and 873 K. At these temperatures, the amount of iron/iron nitride particles increased with increasing annealing time. An increase in the saturation magnetization is explained qualitatively in terms of the amount of such magnetic particles in the film. The resistivity increased monotonously with decreasing Fe content, being consistent with randomly dispersed iron/iron nitride particles in the AlN film. The coercive force was evaluated to be larger than $6.4{ imes}10^3Am^{-1}$ (80 Oe). This large value is ascribed to a residual stress restrained in the ferromagnetic particles, which is considered to be related to the present preparation process.