Background In idiopathic pulmonary fibrosis loss of alveolar epithelium induces inflammation of the pulmonary tissue followed by accumulation of pathogenic myofibroblasts leading eventually to respiratory failures. In animal models inflammatory and resident cells have been demonstrated to contribute to pulmonary fibrosis. Regenerative potential of pulmonary and extra-pulmonary stem and progenitor cells raised the hope for successful treatment option against pulmonary fibrosis. Herein, we addressed the contribution of lung microenvironment and prominin-1+ bone marrow-derived epithelial progenitor cells in the mouse model of bleomycin-induced experimental pulmonary fibrosis. Methods Prominin-1+ bone marrow-derived epithelial progenitors were expanded from adult mouse lungs and differentiated in vitro by cytokines and growth factors. Pulmonary fibrosis was induced in C57Bl/6 mice by intratracheal instillation of bleomycin. Prominin-1+ progenitors were administered intratracheally at different time points after bleomycin challenge. Green fluorescence protein-expressing cells were used for cell tracking. Cell phenotypes were characterized by immunohistochemistry, flow cytometry and quantitative reverse transcription-polymerase chain reaction. Results Prominin-1+ cells expanded from healthy lung represent common progenitors of alveolar type II epithelial cells, myofibroblasts, and macrophages. Administration of prominin-1+ cells 2 hours after bleomycin instillation protects from pulmonary fibrosis, and some of progenitors differentiate into alveolar type II epithelial cells. In contrast, prominin-1+ cells administered at day 7 or 14 lose their protective effects and differentiate into myofibroblasts and macrophages. Bleomycin challenge enhances accumulation of bone marrow-derived prominin-1+ cells within inflamed lung. In contrast to prominin-1+ cells from healthy lung, prominin-1+ precursors isolated from inflamed organ lack regenerative properties but acquire myofibroblast and macrophage phenotypes. Conclusion The microenvironment of inflamed lung impairs the regenerative capacity of bone marrow-derived prominin-1+ progenitors and promotes their differentiation into pathogenic phenotypes.