Calcineurin inhibitor-based graft-versus-host disease (GVHD) prophylaxis is standard in allogeneic hematopoietic stem cell transplantation (HCT) but fails to induce long-term tolerance without chronic GVHD (cGVHD) in a considerable number of patients. In this study, we addressed this long-standing question in mouse models of HCT. After HCT, alloreactive donor T cells rapidly differentiated into PD-1+ TIGIT+ terminally exhausted T cells (terminal Tex). GVHD prophylaxis with cyclosporine (CSP) suppressed donor T-cell expression of TOX, a master regulator to promote differentiation of transitory exhausted T cells (transitory Tex), expressing both inhibitory receptors and effector molecules, into terminal Tex, and inhibited tolerance induction. Adoptive transfer of transitory Tex, but not terminal Tex, into secondary recipients developed cGVHD. Transitory Tex maintained alloreactivity and thus PD-1 blockade restored graft-versus-leukemia (GVL) activity of transitory Tex and not terminal Tex. In conclusion, CSP inhibits tolerance induction by suppressing the terminal exhaustion of donor T cells, while maintaining GVL effects to suppress leukemia relapse.