diff --git a/src/vs/editor/browser/widget/diffEditor/diffProviderFactoryService.ts b/src/vs/editor/browser/widget/diffEditor/diffProviderFactoryService.ts
index 78ac5d5e567720..d4dc992798d728 100644
--- a/src/vs/editor/browser/widget/diffEditor/diffProviderFactoryService.ts
+++ b/src/vs/editor/browser/widget/diffEditor/diffProviderFactoryService.ts
@@ -151,6 +151,31 @@ export class WorkerBasedDocumentDiffProvider implements IDocumentDiffProvider, I
 			throw new Error('no diff result available');
 		}
 
+		// If the advanced algorithm timed out, retry with the legacy algorithm using remaining budget
+		if (result.quitEarly && typeof this.diffAlgorithm === 'string' && this.diffAlgorithm !== 'legacy') {
+			const remainingTimeMs = options.maxComputationTimeMs === 0 ? 0 : options.maxComputationTimeMs - timeMs;
+			if (remainingTimeMs < 0) {
+				// Budget exhausted, skip the fallback
+				if (WorkerBasedDocumentDiffProvider.diffCache.size > 10) {
+					WorkerBasedDocumentDiffProvider.diffCache.delete(WorkerBasedDocumentDiffProvider.diffCache.keys().next().value!);
+				}
+				WorkerBasedDocumentDiffProvider.diffCache.set(uriKey, { result, context });
+				return result;
+			}
+			const legacyOptions = { ...options, maxComputationTimeMs: remainingTimeMs };
+			const legacyResult = await this.editorWorkerService.computeDiff(original.uri, modified.uri, legacyOptions, 'legacy');
+			if (cancellationToken.isCancellationRequested) {
+				return { changes: [], identical: false, quitEarly: true, moves: [] };
+			}
+			if (legacyResult) {
+				if (WorkerBasedDocumentDiffProvider.diffCache.size > 10) {
+					WorkerBasedDocumentDiffProvider.diffCache.delete(WorkerBasedDocumentDiffProvider.diffCache.keys().next().value!);
+				}
+				WorkerBasedDocumentDiffProvider.diffCache.set(uriKey, { result: legacyResult, context });
+				return legacyResult;
+			}
+		}
+
 		// max 10 items in cache
 		if (WorkerBasedDocumentDiffProvider.diffCache.size > 10) {
 			WorkerBasedDocumentDiffProvider.diffCache.delete(WorkerBasedDocumentDiffProvider.diffCache.keys().next().value!);
diff --git a/src/vs/editor/test/browser/widget/diffProviderFactoryService.test.ts b/src/vs/editor/test/browser/widget/diffProviderFactoryService.test.ts
new file mode 100644
index 00000000000000..3d22a913b451e3
--- /dev/null
+++ b/src/vs/editor/test/browser/widget/diffProviderFactoryService.test.ts
@@ -0,0 +1,130 @@
+/*---------------------------------------------------------------------------------------------
+ *  Copyright (c) Microsoft Corporation. All rights reserved.
+ *  Licensed under the MIT License. See License.txt in the project root for license information.
+ *--------------------------------------------------------------------------------------------*/
+
+import assert from 'assert';
+import { CancellationToken } from '../../../../base/common/cancellation.js';
+import { URI } from '../../../../base/common/uri.js';
+import { ensureNoDisposablesAreLeakedInTestSuite } from '../../../../base/test/common/utils.js';
+import { WorkerBasedDocumentDiffProvider } from '../../../browser/widget/diffEditor/diffProviderFactoryService.js';
+import { LineRange } from '../../../common/core/ranges/lineRange.js';
+import { IDocumentDiff, IDocumentDiffProviderOptions } from '../../../common/diff/documentDiffProvider.js';
+import { DetailedLineRangeMapping, RangeMapping } from '../../../common/diff/rangeMapping.js';
+import { IEditorWorkerService, DiffAlgorithmName } from '../../../common/services/editorWorker.js';
+import { ITextModel } from '../../../common/model.js';
+import { NullTelemetryService } from '../../../../platform/telemetry/common/telemetryUtils.js';
+import { Range } from '../../../common/core/range.js';
+
+suite('WorkerBasedDocumentDiffProvider', () => {
+
+	const store = ensureNoDisposablesAreLeakedInTestSuite();
+
+	function createMockTextModel(uri: URI, lineCount: number): ITextModel {
+		return {
+			uri,
+			id: uri.toString(),
+			isDisposed: () => false,
+			getLineCount: () => lineCount,
+			getLineMaxColumn: () => 10,
+			getAlternativeVersionId: () => 1,
+			getFullModelRange: () => new Range(1, 1, lineCount, 10),
+		} as unknown as ITextModel;
+	}
+
+	test('falls back to legacy algorithm when advanced quits early', async () => {
+		const originalUri = URI.parse('file:///original.txt');
+		const modifiedUri = URI.parse('file:///modified.txt');
+
+		const advancedResult: IDocumentDiff = {
+			changes: [],
+			identical: false,
+			quitEarly: true,
+			moves: [],
+		};
+
+		const legacyResult: IDocumentDiff = {
+			changes: [
+				new DetailedLineRangeMapping(
+					new LineRange(1, 5),
+					new LineRange(1, 8),
+					[new RangeMapping(new Range(1, 1, 4, 10), new Range(1, 1, 7, 10))]
+				)
+			],
+			identical: false,
+			quitEarly: false,
+			moves: [],
+		};
+
+		let lastAlgorithmUsed: DiffAlgorithmName | undefined;
+
+		const mockEditorWorkerService: Partial<IEditorWorkerService> = {
+			computeDiff(_original: URI, _modified: URI, _options: IDocumentDiffProviderOptions, algorithm: DiffAlgorithmName): Promise<IDocumentDiff | null> {
+				lastAlgorithmUsed = algorithm;
+				if (algorithm === 'advanced') {
+					return Promise.resolve(advancedResult);
+				}
+				return Promise.resolve(legacyResult);
+			}
+		};
+
+		const provider = store.add(new WorkerBasedDocumentDiffProvider(
+			{ diffAlgorithm: 'advanced' },
+			mockEditorWorkerService as IEditorWorkerService,
+			NullTelemetryService,
+		));
+
+		const original = createMockTextModel(originalUri, 100);
+		const modified = createMockTextModel(modifiedUri, 120);
+
+		const result = await provider.computeDiff(original, modified, {
+			ignoreTrimWhitespace: true,
+			maxComputationTimeMs: 5000,
+			computeMoves: false,
+		}, CancellationToken.None);
+
+		assert.strictEqual(lastAlgorithmUsed, 'legacy');
+		assert.strictEqual(result.quitEarly, false);
+		assert.strictEqual(result.changes.length, 1);
+	});
+
+	test('does not fallback when legacy algorithm quits early', async () => {
+		const originalUri = URI.parse('file:///original2.txt');
+		const modifiedUri = URI.parse('file:///modified2.txt');
+
+		const legacyQuitEarlyResult: IDocumentDiff = {
+			changes: [],
+			identical: false,
+			quitEarly: true,
+			moves: [],
+		};
+
+		const callLog: DiffAlgorithmName[] = [];
+
+		const mockEditorWorkerService: Partial<IEditorWorkerService> = {
+			computeDiff(_original: URI, _modified: URI, _options: IDocumentDiffProviderOptions, algorithm: DiffAlgorithmName): Promise<IDocumentDiff | null> {
+				callLog.push(algorithm);
+				return Promise.resolve(legacyQuitEarlyResult);
+			}
+		};
+
+		const provider = store.add(new WorkerBasedDocumentDiffProvider(
+			{ diffAlgorithm: 'legacy' },
+			mockEditorWorkerService as IEditorWorkerService,
+			NullTelemetryService,
+		));
+
+		const original = createMockTextModel(originalUri, 100);
+		const modified = createMockTextModel(modifiedUri, 120);
+
+		const result = await provider.computeDiff(original, modified, {
+			ignoreTrimWhitespace: true,
+			maxComputationTimeMs: 5000,
+			computeMoves: false,
+		}, CancellationToken.None);
+
+		// Should only call once with legacy, no retry
+		assert.deepStrictEqual(callLog, ['legacy']);
+		assert.strictEqual(result.quitEarly, true);
+	});
+});