Severe viral pneumonia can induce rapid expansion of KRT5+ basal-like cells in small airways and alveoli; this forms a scar-like structure that persists in the injured alveoli and impedes normal alveolar epithelium regeneration. In this study, we investigated the mechanism by which viral infection induced this remodeling response. Through comparing different lung-injury models, we demonstrated that infection induced strong IFN-γ signal-stimulated dysplastic KRT5+ cell formation. Inactivation of interferon receptor 1 (Ifngr1) reduced dysplastic cell formation, ameliorated lung fibrosis, and improved lung-function recovery. Mechanistically, IFN-γ regulated dysplastic cell formation via the focal adhesion kinase (FAK)/Yes-associated protein 1 (YAP) pathway. Inhibiting FAK/Src diminished IFN-γ-induced YAP nuclear translocation and dysplastic cell formation. Inhibiting YAP during viral infection prevented dysplastic cell formation, whereas inhibiting YAP in persistent KRT5+ cells led to their conversion into distal club cells. Importantly, human dysplastic cells exhibited elevated FAK and YAP activity, and IFN-γ treatment promoted the transformation of human alveolar progenitor cells into dysplastic cells. These findings uncover the role of infection-induced inflammatory response in alveolar remodeling and may provide potential therapeutic avenues for the treatment of alveolar remodeling in patients with severe viral pneumonia.