The long-term health effects of SARS-CoV-2, termed Post-Acute Sequelae of COVID-19 (PASC), are quickly evolving into a major public health concern, but the underlying cellular and molecular etiology remain poorly defined. There is growing evidence that PASC is linked to abnormal immune responses and/or poor organ recovery post-infection. However, the exact processes linking non-resolving inflammation, impaired tissue repair, and PASC are still unclear. In this report, we utilized a cohort of respiratory PASC patients with viral infection-mediated pulmonary fibrosis and a clinically relevant mouse model of post-viral lung sequelae to investigate the pathophysiology of respiratory PASC. Using a combination of imaging and spatial transcriptomics, we identified dysregulated proximal interactions between immune cells and epithelial progenitors unique to respiratory PASC but not acute COVID-19 or idiopathic pulmonary fibrosis (IPF). Specifically, we found a central role for lung-resident CD8+ T cell-macrophage interactions in maintaining Krt8hi transitional and ectopic Krt5+ basal cell progenitors, and the development of fibrotic sequelae after acute viral pneumonia. Mechanistically, CD8+ T cell derived IFN-γ and TNF stimulated lung macrophages to chronically release IL-1β, resulting in the abnormal accumulation of dysplastic epithelial progenitors in fibrotic areas. Notably, therapeutic neutralization of IFN-γ and TNF, or IL-1β after the resolution of acute infection resulted in markedly improved alveolar regeneration and restoration of pulmonary function. Together, our findings implicate a dysregulated immune-epithelial progenitor niche in driving respiratory PASC and identify potential therapeutic targets to dampen chronic pulmonary sequelae post respiratory viral infections including SARS-CoV-2.