Biomaterial scaffolds are central to many regenerative strategies as they create a space for infiltration of host tissue and provide a platform to deliver growth factors and progenitor cells. However, biomaterial implantation results in an unavoidable inflammatory response, which can impair tissue regeneration and promote loss or dysfunction of transplanted cells. We investigated localized TGF-β1 delivery to modulate this immunological environment around scaffolds and transplanted cells. TGF-β1 was delivered from layered scaffolds, with protein entrapped within an inner layer and outer layers designed for cell seeding and host tissue integration. Scaffolds were implanted into the epididymal fat pad, a site frequently used for cell transplantation. Expression of cytokines TNF-α, IL-12, and MCP-1 were decreased by at least 40% for scaffolds releasing TGF-β1 relative to control scaffolds. This decrease in inflammatory cytokine production corresponded to a 60% decrease in leukocyte infiltration. Transplantation of islets into diabetic mice on TGF-β1 scaffolds significantly improved the ability of syngeneic islets to control blood glucose levels within the first week of transplant and delayed rejection of allogeneic islets. Together, these studies emphasize the ability of localized TGF-β1 delivery to modulate the immune response to biomaterial implants and enhance cell function in cell-based therapies.