Stem cells undergo dynamic changes in response to injury to regenerate lost cells. However, the identity of transitional states and the mechanisms that drive their trajectories remain understudied. Using lung organoids, multiple in vivo repair models, single-cell transcriptomics and lineage tracing, we find that alveolar type-2 epithelial cells undergoing differentiation into type-1 cells acquire pre-alveolar type-1 transitional cell state (PATS) en route to terminal maturation. Transitional cells undergo extensive stretching during differentiation, making them vulnerable to DNA damage. Cells in the PATS show an enrichment of TP53, TGFβ, DNA-damage-response signalling and cellular senescence. Gain and loss of function as well as genomic binding assays revealed a direct transcriptional control of PATS by TP53 signalling. Notably, accumulation of PATS-like cells in human fibrotic lungs was observed, suggesting persistence of the transitional state in fibrosis. Our study thus implicates a transient state associated with senescence in normal epithelial tissue repair and its abnormal persistence in disease conditions.