Clinical tolerance without immunosuppression has now been achieved for organ transplantation, and its scope will likely continue to expand. In this context, a previously understudied and now increasingly relevant area is how microbial infections might affect the efficacy of tolerance. A highly prevalent and clinically relevant posttransplant pathogen is cytomegalovirus (CMV). Its impact on transplantation tolerance and graft outcomes is not well defined. Employing a mouse model of CMV (MCMV) infection and allogeneic pancreatic islet transplantation in which donor-specific tolerance was induced by infusing donor splenocytes rendered apoptotic by treatment with ethylenecarbodiimide, we investigated the effect of CMV infection on transplantation tolerance induction. We found that acute MCMV infection abrogated tolerance induction and that this abrogation correlated with an alteration in the differentiation and function of myeloid-derived suppressor cells (MDSCs). These effects on MDSCs were mediated in part through MCMV induced type 1 interferon (IFN) production. During MCMV infection, the highly immunosuppressive Gr1^HI-granulocytic MDSCs were markedly reduced in numbers, and the accumulating Ly6C^HI-monocytic cells lost their MDSC-like function but instead acquired an immunostimulatory phenotype to cross-present alloantigens and prime alloreactive CD8 T cells. Consequently, the islet allograft exhibited an altered effector to regulatory T-cell ratio that correlated with the ultimate graft demise. Blocking type 1 IFN signaling during MCMV infection rescued MDSC populations and partially restored transplantation tolerance. Our mechanistic studies now provide a solid foundation for seeking effective therapies for promoting transplantation tolerance in settings of CMV infection.