diff --git a/Extension/src/common.ts b/Extension/src/common.ts
index c84f94290..60a8ff72e 100644
--- a/Extension/src/common.ts
+++ b/Extension/src/common.ts
@@ -399,14 +399,12 @@ export function resolveVariables(input: string | undefined, additionalEnvironmen
     const cycleCache = new Set<string>();
     while (!cycleCache.has(ret)) {
         cycleCache.add(ret);
-        ret = ret.replace(regexp(), (match: string, ignored1: string, varType: string, ignored2: string, name: string) => {
-            // Historically, if the variable didn't have anything before the "." or ":"
-            // it was assumed to be an environment variable
-            if (!varType) {
-                varType = "env";
-            }
+        ret = ret.replace(regexp(), (match: string, ignored1: string | undefined, varType: string | undefined, ignored2: string | undefined, name: string) => {
             let newValue: string | undefined;
             switch (varType) {
+                // Historically, if the variable didn't have anything before the "." or ":"
+                // it was assumed to be an environment variable
+                case undefined:
                 case "env": {
                     if (additionalEnvironment) {
                         const v: string | string[] | undefined = additionalEnvironment[name];
@@ -425,6 +423,12 @@ export function resolveVariables(input: string | undefined, additionalEnvironmen
                     if (newValue === undefined) {
                         newValue = process.env[name];
                     }
+
+                    // If the environment variable is not set, we return an empty string. Only do
+                    // this for ${env:X} variables, not ${X} variables.
+                    if (newValue === undefined && varType !== undefined) {
+                        newValue = "";
+                    }
                     break;
                 }
                 case "config": {
diff --git a/Extension/test/scenarios/SingleRootProject/tests/common.test.ts b/Extension/test/scenarios/SingleRootProject/tests/common.test.ts
index e04c88ea2..3c9e625a6 100644
--- a/Extension/test/scenarios/SingleRootProject/tests/common.test.ts
+++ b/Extension/test/scenarios/SingleRootProject/tests/common.test.ts
@@ -199,6 +199,23 @@ suite("resolveVariables", () => {
             .shouldLookupSymbol("Root");
     });
 
+    test("${env:X} expands to empty when unset", () => {
+        const processKey: string = `cpptoolstests_unset_${Date.now()}`;
+        delete process.env[processKey];
+        resolveVariablesWithInput("${env:" + processKey + "}")
+            .withEnvironment({})
+            .shouldResolveTo("");
+    });
+
+    test("${X} left unexpanded when unset", () => {
+        const processKey: string = `cpptoolstests_unset_${Date.now()}`;
+        delete process.env[processKey];
+        const token: string = "${" + processKey + "}";
+        resolveVariablesWithInput(token)
+            .withEnvironment({})
+            .shouldResolveTo(token);
+    });
+
     test("escapeForSquiggles:", () => {
         const testEscapeForSquigglesScenario: any = (input: string, expectedOutput: string) => {
             const result: string = escapeForSquiggles(input);