Age-associated decline in regeneration capacity limits the restoration of nervous system functionality after injury. In a model for demyelination, we found that old mice fail to resolve the inflammatory response initiated after myelin damage. Aged phagocytes accumulated excessive amounts of myelin debris, which triggered cholesterol crystal formation and phagolysosomal membrane rupture and stimulated inflammasomes. Myelin debris clearance required cholesterol transporters, including apolipoprotein E. Stimulation of reverse cholesterol transport was sufficient to restore the capacity of old mice to remyelinate lesioned tissue. Thus, cholesterol-rich myelin debris can overwhelm the efflux capacity of phagocytes, resulting in a phase transition of cholesterol into crystals and thereby inducing a maladaptive immune response that impedes tissue regeneration.