The effect of microstructure on the ductility and fracture resistance of Zr-1.2Sn-1Nb-(0.2–0.5)Fe alloy has been studied. Different structural states of the alloy were attained by varying the iron content and working/heat treatment schedules, which comprised quenching, cold work, and anneal. The results of the tests for uniaxial tension, impact toughness, and static crack resistance as well as the electron microscope analysis of the microstructure revealed that the main structural factors governing the level of the as-recrystallized alloy ductility and fracture resistance are the sizes and uniformity of distribution of intermetallic particles of different types in the matrix. The highest ductility and impact toughness are reached when fine intermetallic particles from 0.03 to 0.20 μm are distributed uniformly within the structure. The impact toughness and critical crack opening grow linearly with an increase of particle distribution density and a decrease in interparticle spacing. Changes in the alloy microstructure and mechanical properties were investigated upon its anneal after β-quenching. It is demonstrated that the highest values of ductility and impact toughness are reached with the formation of a polygonized matrix structure without intermetallic particle precipitation.