The synthesis of multifunctional magnetic nanoparticles (NPs) is a highly active area of current research located at the interface between materials science, biotechnology and medicine. By virtue of their unique physical properties magnetic nanoparticles are emerging as a new class of diagnostic probes for multimodal tracking and as contrast agents for MRI. Furthermore, they show great potential as carriers for targeted drug and gene delivery, since reactive agents, such as drug molecules or large biomolecules (including genes and antibodies), can easily be attached to their surface. On the other hand, the fate of the nanoparticles inside the body is mainly determined by the interactions with its local environment. These interactions strongly depend upon the size of the magnetic NPs but also on the individual surface characteristics, like charge, morphology and surface chemistry. This review not only summarizes the most common synthetic approaches for the generation of magnetic NPs, it also focuses on different surface modification strategies that are used today to enhance the biocompatibility of these NPs. Finally, key considerations for the application of magnetic NPs in biomedicine, as well as various examples for the utilization in multimodal imaging and targeted gene delivery are presented.