diff --git a/extensions/markdown-language-features/media/markdown.css b/extensions/markdown-language-features/media/markdown.css
index b468a73103d..85e49ca3b6f 100644
--- a/extensions/markdown-language-features/media/markdown.css
+++ b/extensions/markdown-language-features/media/markdown.css
@@ -134,7 +134,8 @@ body.showEditorSelection .code-line {
 	z-index: 2;
 }
 
-.diff-change-indicator-arrow:hover > .diff-change-indicator-tooltip {
+.diff-change-indicator-arrow:hover > .diff-change-indicator-tooltip,
+.diff-change-indicator-arrow > .diff-change-indicator-tooltip:hover {
 	display: block;
 }
 
@@ -179,12 +180,13 @@ body.showEditorSelection .code-line {
 	cursor: pointer;
 }
 
-.diff-modification-gutter:hover > .diff-change-indicator-tooltip {
+.diff-modification-gutter:hover > .diff-change-indicator-tooltip,
+.diff-modification-gutter > .diff-change-indicator-tooltip:hover {
 	display: block;
 }
 
 .diff-modification-gutter > .diff-change-indicator-tooltip {
-	left: 8px;
+	left: 4px;
 	top: 0;
 	right: auto;
 	width: max-content;
@@ -201,14 +203,18 @@ body.showEditorSelection .code-line {
 	background-color: var(--vscode-editor-background);
 	border: 1px solid var(--vscode-editorWidget-border, var(--vscode-contrastBorder, rgba(127, 127, 127, 0.35)));
 	border-radius: 3px;
-	max-height: 400px;
-	overflow: auto;
+	max-height: min(400px, 80vh);
+	overflow-y: auto;
+	overflow-x: hidden;
+	overscroll-behavior: contain;
 	box-shadow: 0 2px 8px rgba(0, 0, 0, 0.2);
 }
 
 .diff-change-indicator-tooltip pre {
 	margin: 0;
 	font-size: 0.9em;
+	background: transparent;
+	border: 0;
 	white-space: pre-wrap;
 	word-break: break-word;
 	color: var(--vscode-editor-foreground);
@@ -217,32 +223,30 @@ body.showEditorSelection .code-line {
 .diff-tooltip-deleted {
 	background-color: var(--vscode-diffEditor-removedTextBackground);
 	border-left: 4px solid var(--vscode-diffEditorGutter-removedLineBackground, var(--vscode-diffEditor-removedTextBackground));
-	padding: 4px 8px;
+	padding: 2px 6px;
 }
 
 .diff-tooltip-added {
 	background-color: var(--vscode-diffEditor-insertedTextBackground);
 	border-left: 4px solid var(--vscode-diffEditorGutter-insertedLineBackground, var(--vscode-diffEditor-insertedTextBackground));
-	padding: 4px 8px;
+	padding: 2px 6px;
 }
 
-.diff-tooltip-unchanged {
-	padding: 4px 8px;
-	border-left: 4px solid transparent;
+.diff-tooltip-inner-deleted,
+.diff-tooltip-inner-added {
+	box-decoration-break: clone;
 }
 
-.diff-inline-deleted {
+.diff-tooltip-inner-deleted {
 	background-color: var(--vscode-diffEditor-removedTextBackground);
 	text-decoration: line-through;
 	text-decoration-color: var(--vscode-editor-foreground);
 }
 
-.diff-inline-added {
+.diff-tooltip-inner-added {
 	background-color: var(--vscode-diffEditor-insertedTextBackground);
 }
 
-
-
 body.showEditorSelection :not(tr,ul,ol).code-active-line:before,
 body.showEditorSelection :not(tr,ul,ol).code-line:hover:before {
 	content: "";
diff --git a/extensions/markdown-language-features/preview-src/index.ts b/extensions/markdown-language-features/preview-src/index.ts
index 846651e8d39..dc2b28c054d 100644
--- a/extensions/markdown-language-features/preview-src/index.ts
+++ b/extensions/markdown-language-features/preview-src/index.ts
@@ -6,11 +6,11 @@
 import { ActiveLineMarker } from './activeLineMarker';
 import { onceDocumentLoaded } from './events';
 import { createPosterForVsCode } from './messaging';
-import { getEditorLineNumberForPageOffset, getElementsForSourceLine, getLineElementForFragment, scrollToRevealSourceLine } from './scroll-sync';
+import { getEditorLineNumberForPageOffset, getElementsForSourceLine, getElementsForSourceLineRange, getLineElementForFragment, scrollToRevealSourceLine } from './scroll-sync';
 import { SettingsManager, getData, getRawData } from './settings';
 import throttle = require('lodash.throttle');
 import morphdom from 'morphdom';
-import type { MarkdownPreviewLineChanges, ToWebviewMessage } from '../types/previewMessaging';
+import type { MarkdownPreviewChangeIndicator, MarkdownPreviewInnerChange, MarkdownPreviewLineChanges, ToWebviewMessage } from '../types/previewMessaging';
 import { isOfScheme, Schemes } from '../src/util/schemes';
 import { DiffScrollSyncManager } from './diffScrollSync';
 
@@ -384,62 +384,82 @@ function applyChangeIndicators(lineChanges: MarkdownPreviewLineChanges | undefin
 		return;
 	}
 
-	for (const indicator of lineChanges.changeIndicators) {
-		const { previous, next } = getElementsForSourceLine(indicator.modifiedLine, documentVersion);
+	for (const block of getRenderedChangeBlocks(lineChanges.changeIndicators)) {
+		if (block.indicator.type === 'deletion') {
+			const wrapper = createChangeIndicatorElement(block.indicator);
+			block.elements[0].parentElement?.insertBefore(wrapper, block.elements[0]);
+			continue;
+		}
 
-		if (indicator.type === 'deletion') {
-			// For pure deletions, the indicator should appear just before the line at modifiedLine.
-			// Use `next` if previous doesn't exactly match the target line, since the deletion
-			// point is between two elements.
-			const targetElement = (previous.line === indicator.modifiedLine)
-				? (previous.codeElement || previous.element)
-				: (next?.codeElement || next?.element || previous.codeElement || previous.element);
-			if (!targetElement) {
-				continue;
-			}
-
-			const wrapper = createChangeIndicatorElement(indicator);
-			targetElement.parentElement?.insertBefore(wrapper, targetElement);
-		} else {
-			// For modifications, mark each modified line and add a gutter bar
-			const seen = new Set<HTMLElement>();
-			let isFirst = true;
-			for (let i = 0; i < indicator.modifiedLineCount; i++) {
-				const line = indicator.modifiedLine + i;
-				const { previous: p, next: n } = getElementsForSourceLine(line, documentVersion);
-				const lineElement = p.line >= 0 ? p : n;
-				const element = (lineElement?.codeElement || lineElement?.element) as HTMLElement | undefined;
-				if (element && !seen.has(element)) {
-					seen.add(element);
-					element.classList.add('code-line-diff-modified');
-					addModificationGutterBar(element, isFirst ? indicator : undefined);
-					isFirst = false;
-				}
-			}
+		let isFirst = true;
+		for (const element of block.elements) {
+			element.classList.add('code-line-diff-modified');
+			addModificationGutterBar(element, isFirst ? block.indicator : undefined);
+			isFirst = false;
 		}
 	}
 }
 
-function createChangeIndicatorElement(indicator: { type: string; originalLineCount: number; originalContent: string; modifiedContent: string }): HTMLDivElement {
+interface RenderedChangeBlock {
+	readonly indicator: MarkdownPreviewChangeIndicator;
+	readonly elements: readonly HTMLElement[];
+}
+
+function getRenderedChangeBlocks(indicators: readonly MarkdownPreviewChangeIndicator[]): RenderedChangeBlock[] {
+	const blocks: RenderedChangeBlock[] = [];
+	for (const indicator of indicators) {
+		const elements = indicator.type === 'deletion'
+			? getDeletionChangeElements(indicator.modifiedLine)
+			: getModificationChangeElements(indicator.modifiedLine, indicator.modifiedLineCount);
+		if (elements.length) {
+			blocks.push({ indicator, elements });
+		}
+	}
+	return blocks;
+}
+
+function getDeletionChangeElements(modifiedLine: number): readonly HTMLElement[] {
+	const { previous, next } = getElementsForSourceLine(modifiedLine, documentVersion);
+	const targetElement = (previous.line === modifiedLine)
+		? (previous.codeElement || previous.element)
+		: (next?.codeElement || next?.element || previous.codeElement || previous.element);
+	return targetElement ? [targetElement] : [];
+}
+
+function getModificationChangeElements(modifiedLine: number, modifiedLineCount: number): readonly HTMLElement[] {
+	const elements: HTMLElement[] = [];
+	const seen = new Set<HTMLElement>();
+	const lineElements = getElementsForSourceLineRange(modifiedLine, modifiedLine + modifiedLineCount, documentVersion);
+	for (const lineElement of lineElements) {
+		const element = lineElement.codeElement || lineElement.element;
+		if (element && !seen.has(element)) {
+			seen.add(element);
+			elements.push(element);
+		}
+	}
+	return elements;
+}
+
+function createChangeIndicatorElement(indicator: MarkdownPreviewChangeIndicator): HTMLDivElement {
 	const wrapper = document.createElement('div');
 	wrapper.className = `diff-change-indicator diff-change-indicator-${indicator.type}`;
 	wrapper.setAttribute('data-original-line-count', String(indicator.originalLineCount));
 
 	const arrowLine = document.createElement('span');
 	arrowLine.className = 'diff-change-indicator-arrow';
-	const tooltip = createDiffTooltip(indicator.originalContent, indicator.modifiedContent);
+	const tooltip = createDiffTooltip(indicator);
 	arrowLine.appendChild(tooltip);
 	wrapper.appendChild(arrowLine);
 
 	return wrapper;
 }
 
-function addModificationGutterBar(element: HTMLElement, indicator?: { originalContent: string; modifiedContent: string }): void {
+function addModificationGutterBar(element: HTMLElement, indicator?: MarkdownPreviewChangeIndicator): void {
 	const gutter = document.createElement('div');
 	gutter.className = 'diff-modification-gutter';
 
 	if (indicator) {
-		const tooltip = createDiffTooltip(indicator.originalContent, indicator.modifiedContent);
+		const tooltip = createDiffTooltip(indicator);
 		gutter.appendChild(tooltip);
 	}
 
@@ -447,201 +467,104 @@ function addModificationGutterBar(element: HTMLElement, indicator?: { originalCo
 	element.appendChild(gutter);
 }
 
-function createDiffTooltip(originalContent: string, modifiedContent: string): HTMLDivElement {
+function createDiffTooltip(indicator: MarkdownPreviewChangeIndicator): HTMLDivElement {
 	const tooltip = document.createElement('div');
 	tooltip.className = 'diff-change-indicator-tooltip';
 
-	const originalLines = originalContent ? originalContent.split('\n') : [];
-	const modifiedLines = modifiedContent ? modifiedContent.split('\n') : [];
-	const lineDiff = computeLineLCS(originalLines, modifiedLines);
-
-	for (const entry of lineDiff) {
-		if (entry.type === 'equal') {
-			// Show unchanged lines in both sections with no highlight
-			const section = document.createElement('div');
-			section.className = 'diff-tooltip-unchanged';
-			const pre = document.createElement('pre');
-			pre.textContent = entry.text;
-			section.appendChild(pre);
-			tooltip.appendChild(section);
-		} else if (entry.type === 'delete') {
-			const section = document.createElement('div');
-			section.className = 'diff-tooltip-deleted';
-			const pre = document.createElement('pre');
-			pre.textContent = entry.text;
-			section.appendChild(pre);
-			tooltip.appendChild(section);
-		} else if (entry.type === 'insert') {
-			const section = document.createElement('div');
-			section.className = 'diff-tooltip-added';
-			const pre = document.createElement('pre');
-			pre.textContent = entry.text;
-			section.appendChild(pre);
-			tooltip.appendChild(section);
-		} else if (entry.type === 'modify') {
-			// Show old and new with word-level highlights
-			const delSection = document.createElement('div');
-			delSection.className = 'diff-tooltip-deleted';
-			const delPre = document.createElement('pre');
-			appendInlineHighlights(delPre, entry.oldTokens!, entry.newTokens!, 'delete');
-			delSection.appendChild(delPre);
-			tooltip.appendChild(delSection);
-
-			const addSection = document.createElement('div');
-			addSection.className = 'diff-tooltip-added';
-			const addPre = document.createElement('pre');
-			appendInlineHighlights(addPre, entry.oldTokens!, entry.newTokens!, 'insert');
-			addSection.appendChild(addPre);
-			tooltip.appendChild(addSection);
-		}
+	if (indicator.originalContent) {
+		appendDiffTooltipSection(tooltip, 'diff-tooltip-deleted', indicator.originalContent, indicator.originalInnerChanges, 'diff-tooltip-inner-deleted');
+	}
+	if (indicator.modifiedContent) {
+		appendDiffTooltipSection(tooltip, 'diff-tooltip-added', indicator.modifiedContent, indicator.modifiedInnerChanges, 'diff-tooltip-inner-added');
 	}
 
 	return tooltip;
 }
 
-interface DiffEntry {
-	type: 'equal' | 'delete' | 'insert' | 'modify';
-	text: string;
-	oldTokens?: string[];
-	newTokens?: string[];
+function appendDiffTooltipSection(tooltip: HTMLElement, className: string, content: string, innerChanges: readonly MarkdownPreviewInnerChange[] | undefined, innerChangeClassName: string): void {
+	const section = document.createElement('div');
+	section.className = className;
+	const pre = document.createElement('pre');
+	appendDiffTooltipContent(pre, content, innerChanges, innerChangeClassName);
+	section.appendChild(pre);
+	tooltip.appendChild(section);
 }
 
-/**
- * Compute a line-level diff using LCS, grouping adjacent changed lines.
- * When a block has both deletions and insertions, pairs them as 'modify' for inline highlighting.
- */
-function computeLineLCS(oldLines: string[], newLines: string[]): DiffEntry[] {
-	const m = oldLines.length;
-	const n = newLines.length;
-
-	// Build LCS table
-	const dp: number[][] = Array.from({ length: m + 1 }, () => new Array(n + 1).fill(0));
-	for (let i = 1; i <= m; i++) {
-		for (let j = 1; j <= n; j++) {
-			if (oldLines[i - 1] === newLines[j - 1]) {
-				dp[i][j] = dp[i - 1][j - 1] + 1;
-			} else {
-				dp[i][j] = Math.max(dp[i - 1][j], dp[i][j - 1]);
-			}
-		}
+function appendDiffTooltipContent(container: HTMLElement, content: string, innerChanges: readonly MarkdownPreviewInnerChange[] | undefined, innerChangeClassName: string): void {
+	if (!innerChanges?.length) {
+		container.textContent = content;
+		return;
 	}
 
-	// Backtrack to get diff operations
-	const rawDiff: Array<{ type: 'equal' | 'delete' | 'insert'; line: string }> = [];
-	let i = m, j = n;
-	while (i > 0 || j > 0) {
-		if (i > 0 && j > 0 && oldLines[i - 1] === newLines[j - 1]) {
-			rawDiff.push({ type: 'equal', line: oldLines[i - 1] });
-			i--; j--;
-		} else if (j > 0 && (i === 0 || dp[i][j - 1] >= dp[i - 1][j])) {
-			rawDiff.push({ type: 'insert', line: newLines[j - 1] });
-			j--;
-		} else {
-			rawDiff.push({ type: 'delete', line: oldLines[i - 1] });
-			i--;
+	const innerChangesByLine = groupInnerChangesByLine(innerChanges);
+	const lines = content.split('\n');
+	for (let line = 0; line < lines.length; ++line) {
+		appendDiffTooltipLine(container, lines[line], innerChangesByLine.get(line), innerChangeClassName);
+		if (line + 1 < lines.length) {
+			container.appendChild(document.createTextNode('\n'));
 		}
 	}
-	rawDiff.reverse();
-
-	// Group into entries, pairing adjacent delete/insert blocks as 'modify'
-	const result: DiffEntry[] = [];
-	let idx = 0;
-	while (idx < rawDiff.length) {
-		const item = rawDiff[idx];
-		if (item.type === 'equal') {
-			result.push({ type: 'equal', text: item.line });
-			idx++;
-		} else {
-			// Collect contiguous changed block
-			const delLines: string[] = [];
-			const insLines: string[] = [];
-			while (idx < rawDiff.length && rawDiff[idx].type !== 'equal') {
-				if (rawDiff[idx].type === 'delete') {
-					delLines.push(rawDiff[idx].line);
-				} else {
-					insLines.push(rawDiff[idx].line);
-				}
-				idx++;
-			}
-
-			// Pair up lines for inline highlighting
-			const paired = Math.min(delLines.length, insLines.length);
-			for (let k = 0; k < paired; k++) {
-				result.push({
-					type: 'modify',
-					text: '',
-					oldTokens: tokenize(delLines[k]),
-					newTokens: tokenize(insLines[k]),
-				});
-			}
-			// Remaining unpaired lines
-			for (let k = paired; k < delLines.length; k++) {
-				result.push({ type: 'delete', text: delLines[k] });
-			}
-			for (let k = paired; k < insLines.length; k++) {
-				result.push({ type: 'insert', text: insLines[k] });
-			}
-		}
-	}
-
-	return result;
 }
 
-/** Split a line into alternating word and whitespace tokens */
-function tokenize(line: string): string[] {
-	return line.match(/\S+|\s+/g) || [''];
+function appendDiffTooltipLine(container: HTMLElement, lineText: string, innerChanges: readonly MarkdownPreviewInnerChange[] | undefined, innerChangeClassName: string): void {
+	const normalizedInnerChanges = normalizeInnerChanges(innerChanges, lineText.length);
+	let offset = 0;
+	for (const change of normalizedInnerChanges) {
+		if (offset < change.startColumn) {
+			container.appendChild(document.createTextNode(lineText.slice(offset, change.startColumn)));
+		}
+
+		const span = document.createElement('span');
+		span.className = innerChangeClassName;
+		span.textContent = lineText.slice(change.startColumn, change.endColumn);
+		container.appendChild(span);
+		offset = change.endColumn;
+	}
+
+	if (offset < lineText.length) {
+		container.appendChild(document.createTextNode(lineText.slice(offset)));
+	}
 }
 
-/** Compute LCS indices for two token arrays */
-function tokenLCS(a: string[], b: string[]): Set<number>[] {
-	const m = a.length, n = b.length;
-	const dp: number[][] = Array.from({ length: m + 1 }, () => new Array(n + 1).fill(0));
-	for (let i = 1; i <= m; i++) {
-		for (let j = 1; j <= n; j++) {
-			if (a[i - 1] === b[j - 1]) {
-				dp[i][j] = dp[i - 1][j - 1] + 1;
-			} else {
-				dp[i][j] = Math.max(dp[i - 1][j], dp[i][j - 1]);
-			}
-		}
-	}
-	const aMatch = new Set<number>();
-	const bMatch = new Set<number>();
-	let i = m, j = n;
-	while (i > 0 && j > 0) {
-		if (a[i - 1] === b[j - 1]) {
-			aMatch.add(i - 1);
-			bMatch.add(j - 1);
-			i--; j--;
-		} else if (dp[i][j - 1] >= dp[i - 1][j]) {
-			j--;
+function groupInnerChangesByLine(innerChanges: readonly MarkdownPreviewInnerChange[]): Map<number, readonly MarkdownPreviewInnerChange[]> {
+	const groupedInnerChanges = new Map<number, MarkdownPreviewInnerChange[]>();
+	for (const change of innerChanges) {
+		const lineChanges = groupedInnerChanges.get(change.line);
+		if (lineChanges) {
+			lineChanges.push(change);
 		} else {
-			i--;
+			groupedInnerChanges.set(change.line, [change]);
 		}
 	}
-	return [aMatch, bMatch];
+	return groupedInnerChanges;
 }
 
-/**
- * Append tokens to a <pre> element with inline highlights for changed tokens.
- * @param side 'delete' renders oldTokens highlighting removals; 'insert' renders newTokens highlighting additions
- */
-function appendInlineHighlights(pre: HTMLPreElement, oldTokens: string[], newTokens: string[], side: 'delete' | 'insert'): void {
-	const [oldMatch, newMatch] = tokenLCS(oldTokens, newTokens);
-	const tokens = side === 'delete' ? oldTokens : newTokens;
-	const matchSet = side === 'delete' ? oldMatch : newMatch;
-	const highlightClass = side === 'delete' ? 'diff-inline-deleted' : 'diff-inline-added';
+function normalizeInnerChanges(innerChanges: readonly MarkdownPreviewInnerChange[] | undefined, lineLength: number): { startColumn: number; endColumn: number }[] {
+	if (!innerChanges?.length) {
+		return [];
+	}
 
-	for (let i = 0; i < tokens.length; i++) {
-		if (matchSet.has(i)) {
-			pre.appendChild(document.createTextNode(tokens[i]));
+	const sortedInnerChanges = innerChanges
+		.map(change => ({
+			startColumn: clampColumn(change.startColumn, lineLength),
+			endColumn: clampColumn(change.endColumn, lineLength),
+		}))
+		.filter(change => change.startColumn < change.endColumn)
+		.sort((a, b) => a.startColumn - b.startColumn || a.endColumn - b.endColumn);
+	const normalizedInnerChanges: { startColumn: number; endColumn: number }[] = [];
+	for (const change of sortedInnerChanges) {
+		const previous = normalizedInnerChanges[normalizedInnerChanges.length - 1];
+		if (previous && change.startColumn <= previous.endColumn) {
+			previous.endColumn = Math.max(previous.endColumn, change.endColumn);
 		} else {
-			const span = document.createElement('span');
-			span.className = highlightClass;
-			span.textContent = tokens[i];
-			pre.appendChild(span);
+			normalizedInnerChanges.push(change);
 		}
 	}
+	return normalizedInnerChanges;
+}
+
+function clampColumn(column: number, lineLength: number): number {
+	return Math.min(Math.max(column, 0), lineLength);
 }
 
 
@@ -666,19 +589,11 @@ function applyInnerChangeHighlights(lineChanges: MarkdownPreviewLineChanges | un
 		return;
 	}
 
-	let i = 0;
-	while (true) {
-		const startMarker = root.querySelector(`[data-diff-start="${i}"]`);
-		const endMarker = root.querySelector(`[data-diff-end="${i}"]`);
-		if (!startMarker || !endMarker) {
-			break;
-		}
-
+	for (const { startMarker, endMarker } of getDiffMarkerPairs(root)) {
 		const range = new Range();
 		range.setStartAfter(startMarker);
 		range.setEndBefore(endMarker);
 		ranges.push(range);
-		i++;
 	}
 
 	if (ranges.length > 0) {
@@ -686,6 +601,31 @@ function applyInnerChangeHighlights(lineChanges: MarkdownPreviewLineChanges | un
 	}
 }
 
+interface DiffMarkerPair {
+	readonly startMarker: Element;
+	readonly endMarker: Element;
+}
+
+function getDiffMarkerPairs(root: Element): DiffMarkerPair[] {
+	const endMarkersById = new Map<string, Element>();
+	for (const endMarker of root.querySelectorAll('[data-diff-end]')) {
+		const id = endMarker.getAttribute('data-diff-end');
+		if (id !== null) {
+			endMarkersById.set(id, endMarker);
+		}
+	}
+
+	const pairs: DiffMarkerPair[] = [];
+	for (const startMarker of root.querySelectorAll('[data-diff-start]')) {
+		const id = startMarker.getAttribute('data-diff-start');
+		const endMarker = id === null ? undefined : endMarkersById.get(id);
+		if (endMarker && !(startMarker.compareDocumentPosition(endMarker) & Node.DOCUMENT_POSITION_PRECEDING)) {
+			pairs.push({ startMarker, endMarker });
+		}
+	}
+	return pairs;
+}
+
 
 
 document.addEventListener('dblclick', event => {
diff --git a/extensions/markdown-language-features/preview-src/scroll-sync.ts b/extensions/markdown-language-features/preview-src/scroll-sync.ts
index f4eae58d47c..6c684ea9c14 100644
--- a/extensions/markdown-language-features/preview-src/scroll-sync.ts
+++ b/extensions/markdown-language-features/preview-src/scroll-sync.ts
@@ -99,6 +99,29 @@ export function getElementsForSourceLine(targetLine: number, documentVersion: nu
 	return { previous };
 }
 
+export function getElementsForSourceLineRange(startLine: number, endLine: number, documentVersion: number): readonly CodeLineElement[] {
+	const rangeStart = Math.floor(startLine);
+	const rangeEnd = Math.max(rangeStart + 1, Math.ceil(endLine));
+	const lines = getCodeLineElements(documentVersion).filter(element => element.line >= 0);
+	const elements: CodeLineElement[] = [];
+	for (let i = 0; i < lines.length; i++) {
+		const element = lines[i];
+		const next = lines[i + 1];
+		const elementStart = element.line;
+		const elementEnd = element.endLine !== undefined
+			? element.endLine + 1
+			: (next && next.line > element.line ? next.line : element.line + 1);
+		if (rangesIntersect(rangeStart, rangeEnd, elementStart, elementEnd)) {
+			elements.push(element);
+		}
+	}
+	return elements;
+}
+
+function rangesIntersect(startA: number, endA: number, startB: number, endB: number): boolean {
+	return startA < endB && startB < endA;
+}
+
 /**
  * Find the html elements that are at a specific pixel offset on the page.
  */
diff --git a/extensions/markdown-language-features/preview-src/tsconfig.json b/extensions/markdown-language-features/preview-src/tsconfig.json
index 5c51c32b141..95beb29e157 100644
--- a/extensions/markdown-language-features/preview-src/tsconfig.json
+++ b/extensions/markdown-language-features/preview-src/tsconfig.json
@@ -1,7 +1,7 @@
 {
 	"extends": "../../tsconfig.base.json",
 	"compilerOptions": {
-		"rootDir": ".",
+		"rootDir": "..",
 		"outDir": "./dist/",
 		"jsx": "react",
 		"esModuleInterop": true,
diff --git a/extensions/markdown-language-features/src/preview/lineDiff.ts b/extensions/markdown-language-features/src/preview/lineDiff.ts
index d6d577dcb58..bd5c1d98781 100644
--- a/extensions/markdown-language-features/src/preview/lineDiff.ts
+++ b/extensions/markdown-language-features/src/preview/lineDiff.ts
@@ -21,6 +21,8 @@ interface LineMappings {
 	readonly modifiedToOriginal: number[];
 }
 
+type ChangedLineRange = Pick<vscode.TextDiffChange, 'originalRange' | 'modifiedRange'>;
+
 export class MarkdownPreviewLineDiffProvider {
 
 	readonly #originalDocument: vscode.TextDocument;
@@ -92,7 +94,7 @@ async function computeLineChanges(originalDocument: vscode.TextDocument, modifie
 	const deleted: number[] = [];
 	const originalInnerChanges: MarkdownPreviewInnerChange[] = [];
 	const modifiedInnerChanges: MarkdownPreviewInnerChange[] = [];
-	const changeIndicators: MarkdownPreviewChangeIndicator[] = [];
+	const changedLineRanges: ChangedLineRange[] = [];
 	const mappings = createEmptyLineMappings(originalLineCount, modifiedLineCount);
 
 	let lastOriginalEnd = 0;
@@ -120,22 +122,7 @@ async function computeLineChanges(originalDocument: vscode.TextDocument, modifie
 		// Collect change indicators for deletions and modifications
 		const origChangedCount = origEnd - origStart;
 		if (origChangedCount > 0) {
-			const originalLines: string[] = [];
-			for (let i = origStart; i < origEnd; ++i) {
-				originalLines.push(originalDocument.lineAt(i).text);
-			}
-			const modifiedLines: string[] = [];
-			for (let i = modStart; i < modEnd; ++i) {
-				modifiedLines.push(modifiedDocument.lineAt(i).text);
-			}
-			changeIndicators.push({
-				modifiedLine: modStart,
-				modifiedLineCount: modEnd - modStart,
-				originalLineCount: origChangedCount,
-				originalContent: originalLines.join('\n'),
-				modifiedContent: modifiedLines.join('\n'),
-				type: modEnd === modStart ? 'deletion' : 'modification',
-			});
+			changedLineRanges.push(change);
 		}
 
 		// Collect inner changes (character-level changes within modified lines)
@@ -153,10 +140,88 @@ async function computeLineChanges(originalDocument: vscode.TextDocument, modifie
 	// Map unchanged lines after the last change
 	fillUnchangedLineMappings(mappings, lastOriginalEnd, originalLineCount, lastModifiedEnd, modifiedLineCount);
 	fillMissingLineMappings(mappings);
+	const splitChangedLineRanges = splitChangedLineRangesByMarkdownBlocks(changedLineRanges, originalDocument, modifiedDocument);
+	const changeIndicators = createChangeIndicators(splitChangedLineRanges, originalDocument, modifiedDocument, originalInnerChanges, modifiedInnerChanges);
 
 	return { added, deleted, originalInnerChanges, modifiedInnerChanges, changeIndicators, ...mappings };
 }
 
+function createChangeIndicators(ranges: readonly ChangedLineRange[], originalDocument: vscode.TextDocument, modifiedDocument: vscode.TextDocument, originalInnerChanges: readonly MarkdownPreviewInnerChange[], modifiedInnerChanges: readonly MarkdownPreviewInnerChange[]): MarkdownPreviewChangeIndicator[] {
+	return ranges.map(range => {
+		const modifiedLineCount = range.modifiedRange.end.line - range.modifiedRange.start.line;
+		return {
+			modifiedLine: range.modifiedRange.start.line,
+			modifiedLineCount,
+			originalLineCount: range.originalRange.end.line - range.originalRange.start.line,
+			originalContent: getLineRangeText(originalDocument, range.originalRange),
+			originalInnerChanges: getRelativeInnerChanges(originalInnerChanges, range.originalRange),
+			modifiedContent: getLineRangeText(modifiedDocument, range.modifiedRange),
+			modifiedInnerChanges: getRelativeInnerChanges(modifiedInnerChanges, range.modifiedRange),
+			type: modifiedLineCount === 0 ? 'deletion' : 'modification',
+		};
+	});
+}
+
+function getRelativeInnerChanges(innerChanges: readonly MarkdownPreviewInnerChange[], range: vscode.Range): MarkdownPreviewInnerChange[] | undefined {
+	const relativeInnerChanges: MarkdownPreviewInnerChange[] = [];
+	for (const change of innerChanges) {
+		if (change.line >= range.start.line && change.line < range.end.line) {
+			relativeInnerChanges.push({
+				line: change.line - range.start.line,
+				startColumn: change.startColumn,
+				endColumn: change.endColumn,
+			});
+		}
+	}
+	return relativeInnerChanges.length ? relativeInnerChanges : undefined;
+}
+
+function splitChangedLineRangesByMarkdownBlocks(ranges: readonly ChangedLineRange[], originalDocument: vscode.TextDocument, modifiedDocument: vscode.TextDocument): ChangedLineRange[] {
+	const splitRanges: ChangedLineRange[] = [];
+	for (const range of ranges) {
+		const originalBlocks = getNonBlankLineRanges(originalDocument, range.originalRange);
+		const modifiedBlocks = getNonBlankLineRanges(modifiedDocument, range.modifiedRange);
+		if (originalBlocks.length > 1 && originalBlocks.length === modifiedBlocks.length) {
+			for (let i = 0; i < originalBlocks.length; ++i) {
+				splitRanges.push({
+					originalRange: originalBlocks[i],
+					modifiedRange: modifiedBlocks[i],
+				});
+			}
+		} else {
+			splitRanges.push(range);
+		}
+	}
+	return splitRanges;
+}
+
+function getNonBlankLineRanges(document: vscode.TextDocument, range: vscode.Range): vscode.Range[] {
+	const ranges: vscode.Range[] = [];
+	let blockStartLine: number | undefined;
+	for (let line = range.start.line; line < range.end.line; ++line) {
+		if (document.lineAt(line).text.trim().length === 0) {
+			if (blockStartLine !== undefined) {
+				ranges.push(new vscode.Range(blockStartLine, 0, line, 0));
+				blockStartLine = undefined;
+			}
+		} else if (blockStartLine === undefined) {
+			blockStartLine = line;
+		}
+	}
+	if (blockStartLine !== undefined) {
+		ranges.push(new vscode.Range(blockStartLine, 0, range.end.line, 0));
+	}
+	return ranges;
+}
+
+function getLineRangeText(document: vscode.TextDocument, range: vscode.Range): string {
+	const lines: string[] = [];
+	for (let line = range.start.line; line < range.end.line; ++line) {
+		lines.push(document.lineAt(line).text);
+	}
+	return lines.join('\n');
+}
+
 /**
  * Splits a Range into per-line inner change entries.
  * For single-line ranges, emits one entry. For multi-line ranges,
diff --git a/extensions/markdown-language-features/types/previewMessaging.d.ts b/extensions/markdown-language-features/types/previewMessaging.d.ts
index d0568b5a44e..2258f8ea23d 100644
--- a/extensions/markdown-language-features/types/previewMessaging.d.ts
+++ b/extensions/markdown-language-features/types/previewMessaging.d.ts
@@ -25,8 +25,12 @@ export interface MarkdownPreviewChangeIndicator {
 	readonly originalLineCount: number;
 	/** The original text content that was deleted or replaced */
 	readonly originalContent: string;
+	/** Character-level changes within originalContent, using originalContent-relative line numbers */
+	readonly originalInnerChanges?: readonly MarkdownPreviewInnerChange[];
 	/** The modified text content (for modifications) */
 	readonly modifiedContent: string;
+	/** Character-level changes within modifiedContent, using modifiedContent-relative line numbers */
+	readonly modifiedInnerChanges?: readonly MarkdownPreviewInnerChange[];
 	/** Whether this is a pure deletion or a modification of existing lines */
 	readonly type: 'deletion' | 'modification';
 }