The process by which fetal lung epithelial cells differentiate into type 1 and type 2 cell is largely unknown. In order to study lung epithelial cell proliferation and differentiation we have infected 20-day fetal lung epithelial cells with a retrovirus carrying a temperature-sensitive SV40 T antigen (T Ag) and isolated several immortalized fetal epithelial cell lines. Cell line 20-3 has characteristics of lung epithelial cells including the presence of distinct lamellar bodies, tight junctions, keratin 8 and 18 mRNA, HFH8, and T1 alpha mRNA and low levels of surfactant protein A mRNA. At 33 degrees C 20-3 grows with a doubling time of 21 h. At 40 degrees C the majority of cells cease to proliferate. Growth arrest is accompanied by significant morphological changes including an increase in cell size, transition to a squamous phenotype that resembles type 1 cells, and an increase in the number of multinucleated cells within the population. Greater than 95% of the cells incorporate [3H]thymidine into DNA at 33 degrees C whereas at 40 degrees C label incorporation drops to less than 20%. When shifted down to 33 degrees C 40% of the cells remain terminally growth arrested. In addition, cells plated at 40 degrees C have a reduced ability to form colonies when replated at 33 degrees C. Treatment with TGF-beta increases the percentage of cells that terminally growth arrest to greater than 80%. Growth arrest is accompanied by an increase in the levels of c-jun, jun D, cyclin D1, C/EBP-beta, transglutaminase type II, and retinoblastoma (Rb) mRNA and an induction of p105, the hypophosphorylated, growth regulatory form of Rb. Evaluation of Rb mRNA in fetal lung indicates that it is induced 2.5-fold between 17 and 21 days of gestation. These studies indicate that 20-3 terminally growth arrests in culture at the nonpermissive temperature and that it may be useful in studying changes in gene expression that accompany terminal growth arrest during lung development.