diff --git a/core/tools/implementations/resolveWorkingDirectory.vitest.ts b/core/tools/implementations/resolveWorkingDirectory.vitest.ts
new file mode 100644
index 00000000000..6940af2ea72
--- /dev/null
+++ b/core/tools/implementations/resolveWorkingDirectory.vitest.ts
@@ -0,0 +1,197 @@
+import { describe, expect, it } from "vitest";
+import { fileURLToPath } from "node:url";
+
+/**
+ * Test suite for workspace directory resolution logic.
+ *
+ * This tests the URI parsing behavior used in runTerminalCommand.ts
+ * to ensure correct handling of various workspace URI formats.
+ */
+
+// Replicate the resolution logic for testing
+function resolveWorkingDirectory(workspaceDirs: string[]): string {
+  // Handle vscode-remote://wsl+distro/path URIs (WSL2 remote workspaces)
+  const wslWorkspaceDir = workspaceDirs.find((dir) =>
+    dir.startsWith("vscode-remote://wsl"),
+  );
+  if (wslWorkspaceDir) {
+    try {
+      const url = new URL(wslWorkspaceDir);
+      return decodeURIComponent(url.pathname);
+    } catch {
+      // Fall through to other handlers
+    }
+  }
+
+  // Handle file:// URIs (local workspaces)
+  const fileWorkspaceDir = workspaceDirs.find((dir) =>
+    dir.startsWith("file:/"),
+  );
+  if (fileWorkspaceDir) {
+    try {
+      return fileURLToPath(fileWorkspaceDir);
+    } catch {
+      // Fall through to default handling
+    }
+  }
+
+  // Default to user's home directory with fallbacks
+  try {
+    return process.env.HOME || process.env.USERPROFILE || process.cwd();
+  } catch {
+    return "/tmp";
+  }
+}
+
+describe("resolveWorkingDirectory", () => {
+  describe("WSL remote URIs (vscode-remote://wsl+...)", () => {
+    it("should parse basic WSL URI", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/project",
+      ]);
+      expect(result).toBe("/home/user/project");
+    });
+
+    it("should decode URL-encoded spaces in path", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/my%20project",
+      ]);
+      expect(result).toBe("/home/user/my project");
+    });
+
+    it("should decode URL-encoded special characters", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/path%23with%23hashes",
+      ]);
+      expect(result).toBe("/home/user/path#with#hashes");
+    });
+
+    it("should decode URL-encoded unicode characters", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/%E4%B8%AD%E6%96%87%E8%B7%AF%E5%BE%84",
+      ]);
+      expect(result).toBe("/home/user/中文路径");
+    });
+
+    it("should handle different WSL distro names", () => {
+      const ubuntu = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu-22.04/home/user/project",
+      ]);
+      expect(ubuntu).toBe("/home/user/project");
+
+      const debian = resolveWorkingDirectory([
+        "vscode-remote://wsl+Debian/home/user/project",
+      ]);
+      expect(debian).toBe("/home/user/project");
+    });
+
+    it("should handle root path", () => {
+      const result = resolveWorkingDirectory(["vscode-remote://wsl+Ubuntu/"]);
+      expect(result).toBe("/");
+    });
+
+    it("should prioritize WSL URIs over file:// URIs", () => {
+      const result = resolveWorkingDirectory([
+        "file:///c:/Users/user/project",
+        "vscode-remote://wsl+Ubuntu/home/user/project",
+      ]);
+      expect(result).toBe("/home/user/project");
+    });
+  });
+
+  describe("file:// URIs (local workspaces)", () => {
+    it("should parse basic file:// URI on Unix", () => {
+      const result = resolveWorkingDirectory(["file:///home/user/project"]);
+      expect(result).toBe("/home/user/project");
+    });
+
+    it("should decode URL-encoded spaces in file:// URI", () => {
+      const result = resolveWorkingDirectory([
+        "file:///home/user/my%20project",
+      ]);
+      expect(result).toBe("/home/user/my project");
+    });
+
+    it("should handle Windows-style file:// URI", () => {
+      // fileURLToPath handles Windows paths correctly
+      const result = resolveWorkingDirectory(["file:///C:/Users/user/project"]);
+      // On Unix, this will be /C:/Users/user/project
+      // On Windows, this will be C:\Users\user\project
+      expect(result).toMatch(/project$/);
+    });
+  });
+
+  describe("fallback behavior", () => {
+    it("should fall back to HOME when no valid URIs", () => {
+      const originalHome = process.env.HOME;
+      try {
+        process.env.HOME = "/test/home";
+        const result = resolveWorkingDirectory([]);
+        expect(result).toBe("/test/home");
+      } finally {
+        process.env.HOME = originalHome;
+      }
+    });
+
+    it("should handle empty workspace dirs array", () => {
+      const result = resolveWorkingDirectory([]);
+      // Should return HOME or USERPROFILE or cwd
+      expect(typeof result).toBe("string");
+      expect(result.length).toBeGreaterThan(0);
+    });
+
+    it("should handle invalid URIs gracefully", () => {
+      const result = resolveWorkingDirectory([
+        "not-a-valid-uri",
+        "also://not/handled",
+      ]);
+      // Should fall through to HOME fallback
+      expect(typeof result).toBe("string");
+    });
+
+    it("should handle malformed vscode-remote URI", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu", // Missing path
+      ]);
+      // new URL() should still parse this, pathname would be empty or "/"
+      expect(typeof result).toBe("string");
+    });
+  });
+
+  describe("URL encoding edge cases", () => {
+    it("should handle plus signs (not spaces)", () => {
+      // In URL encoding, + is literal plus, %2B is encoded plus, %20 is space
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/c%2B%2B-project",
+      ]);
+      expect(result).toBe("/home/user/c++-project");
+    });
+
+    it("should handle percent sign itself", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/100%25-complete",
+      ]);
+      expect(result).toBe("/home/user/100%-complete");
+    });
+
+    it("should handle mixed encoded and unencoded characters", () => {
+      const result = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/normal-path/with%20space/more",
+      ]);
+      expect(result).toBe("/home/user/normal-path/with space/more");
+    });
+  });
+
+  describe("comparison with fileURLToPath behavior", () => {
+    it("should match fileURLToPath decoding for equivalent paths", () => {
+      const fileResult = fileURLToPath("file:///home/user/my%20project");
+      const wslResult = resolveWorkingDirectory([
+        "vscode-remote://wsl+Ubuntu/home/user/my%20project",
+      ]);
+
+      // Both should decode %20 to space
+      expect(fileResult).toBe("/home/user/my project");
+      expect(wslResult).toBe("/home/user/my project");
+    });
+  });
+});
diff --git a/core/tools/implementations/runTerminalCommand.ts b/core/tools/implementations/runTerminalCommand.ts
index 19377a4eeb2..bed8aceb85a 100644
--- a/core/tools/implementations/runTerminalCommand.ts
+++ b/core/tools/implementations/runTerminalCommand.ts
@@ -48,12 +48,32 @@ import { getBooleanArg, getStringArg } from "../parseArgs";
  * Falls back to home directory or temp directory if no workspace is available.
  */
 function resolveWorkingDirectory(workspaceDirs: string[]): string {
+  // Handle file:// URIs (local workspaces)
   const fileWorkspaceDir = workspaceDirs.find((dir) =>
     dir.startsWith("file:/"),
   );
   if (fileWorkspaceDir) {
-    return fileURLToPath(fileWorkspaceDir);
+    try {
+      return fileURLToPath(fileWorkspaceDir);
+    } catch {
+      // fileURLToPath can fail on malformed URIs or in some remote environments
+      // Fall through to default handling
+    }
+  }
+
+  // Handle other URI schemes (vscode-remote://wsl, vscode-remote://ssh-remote, etc.)
+  const remoteWorkspaceDir = workspaceDirs.find(
+    (dir) => dir.includes("://") && !dir.startsWith("file:/"),
+  );
+  if (remoteWorkspaceDir) {
+    try {
+      const url = new URL(remoteWorkspaceDir);
+      return decodeURIComponent(url.pathname);
+    } catch {
+      // Fall through to other handlers
+    }
   }
+
   // Default to user's home directory with fallbacks
   try {
     return process.env.HOME || process.env.USERPROFILE || process.cwd();
diff --git a/core/tools/implementations/runTerminalCommand.vitest.ts b/core/tools/implementations/runTerminalCommand.vitest.ts
index 428cc83065a..089c855028e 100644
--- a/core/tools/implementations/runTerminalCommand.vitest.ts
+++ b/core/tools/implementations/runTerminalCommand.vitest.ts
@@ -553,6 +553,58 @@ describe("runTerminalCommandImpl", () => {
         // This demonstrates why the fix is needed - fileURLToPath throws on non-file URIs
         expect(() => fileURLToPath(nonFileUri)).toThrow();
       });
+
+      it("should handle vscode-remote URIs by extracting pathname", async () => {
+        // Various remote URI formats that VS Code uses
+        const remoteUris = [
+          "vscode-remote://wsl+Ubuntu/home/user/project",
+          "vscode-remote://ssh-remote+myserver/home/user/project",
+          "vscode-remote://dev-container+abc123/workspace",
+        ];
+
+        for (const uri of remoteUris) {
+          mockGetWorkspaceDirs.mockResolvedValue([uri]);
+
+          // Should not throw - the generic URI handler extracts the pathname
+          await expect(
+            runTerminalCommandImpl(
+              { command: "echo test", waitForCompletion: false },
+              createMockExtras(),
+            ),
+          ).resolves.toBeDefined();
+        }
+      });
+
+      it("should decode URI-encoded characters in remote workspace paths", async () => {
+        // Path with spaces and special characters
+        const encodedUri =
+          "vscode-remote://wsl+Ubuntu/home/user/my%20project%20%28test%29";
+        mockGetWorkspaceDirs.mockResolvedValue([encodedUri]);
+
+        // Should handle without throwing - decodeURIComponent is applied
+        await expect(
+          runTerminalCommandImpl(
+            { command: "echo test", waitForCompletion: false },
+            createMockExtras(),
+          ),
+        ).resolves.toBeDefined();
+      });
+
+      it("should prefer file:// URIs over remote URIs when both present", async () => {
+        const workspaceDirs = [
+          "vscode-remote://wsl+Ubuntu/home/user/remote-project",
+          "file:///home/user/local-project",
+        ];
+        mockGetWorkspaceDirs.mockResolvedValue(workspaceDirs);
+
+        // Should succeed, preferring the file:// URI
+        await expect(
+          runTerminalCommandImpl(
+            { command: "echo test", waitForCompletion: false },
+            createMockExtras(),
+          ),
+        ).resolves.toBeDefined();
+      });
     });
 
     describe("remote environment handling", () => {