diff --git a/src/tox/config/set_env.py b/src/tox/config/set_env.py
index 0686200c3..339e8f702 100644
--- a/src/tox/config/set_env.py
+++ b/src/tox/config/set_env.py
@@ -34,8 +34,8 @@ def __init__(  # noqa: C901, PLR0912
             return
         for line in raw.splitlines():  # noqa: PLR1702
             if line.strip():
-                if line.startswith("file|"):  # environment files to be handled later
-                    self._env_files.append(line[len("file|") :])
+                if self._is_file_line(line):
+                    self._env_files.append(self._parse_file_line(line))
                 else:
                     try:
                         key, value = self._extract_key_value(line)
@@ -52,12 +52,20 @@ def __init__(  # noqa: C901, PLR0912
                     else:
                         self._raw[key] = value
 
+    @staticmethod
+    def _is_file_line(line: str) -> bool:
+        return line.startswith("file|")
+
+    @staticmethod
+    def _parse_file_line(line: str) -> str:
+        return line[len("file|") :]
+
     def use_replacer(self, value: Replacer, args: ConfigLoadArgs) -> None:
         self._replacer = value
         for filename in self._env_files:
-            self._read_env_file(filename, args)
+            self._raw.update(self._stream_env_file(filename, args))
 
-    def _read_env_file(self, filename: str, args: ConfigLoadArgs) -> None:
+    def _stream_env_file(self, filename: str, args: ConfigLoadArgs) -> Iterator[tuple[str, str]]:
         # Our rules in the documentation, some upstream environment file rules (we follow mostly the docker one):
         # - https://www.npmjs.com/package/dotenv#rules
         # - https://docs.docker.com/compose/env-file/
@@ -70,8 +78,7 @@ def _read_env_file(self, filename: str, args: ConfigLoadArgs) -> None:
             env_line = env_line.strip()  # noqa: PLW2901
             if not env_line or env_line.startswith("#"):
                 continue
-            key, value = self._extract_key_value(env_line)
-            self._raw[key] = value
+            yield self._extract_key_value(env_line)
 
     @staticmethod
     def _extract_key_value(line: str) -> tuple[str, str]:
@@ -100,10 +107,18 @@ def __iter__(self) -> Iterator[str]:
         # start with the materialized ones, maybe we don't need to materialize the raw ones
         yield from self._materialized.keys()
         yield from list(self._raw.keys())  # iterating over this may trigger materialization and change the dict
+        args = ConfigLoadArgs([], self._name, self._env_name)
         while self._needs_replacement:
             line = self._needs_replacement.pop(0)
-            expanded_line = self._replacer(line, ConfigLoadArgs([], self._name, self._env_name))
-            sub_raw = dict(self._extract_key_value(sub_line) for sub_line in expanded_line.splitlines() if sub_line)
+            expanded_line = self._replacer(line, args)
+            sub_raw: dict[str, str] = {}
+            for sub_line in filter(None, expanded_line.splitlines()):
+                if not self._is_file_line(sub_line):
+                    sub_raw.__setitem__(*self._extract_key_value(sub_line))
+                else:
+                    for k, v in self._stream_env_file(self._parse_file_line(sub_line), args):
+                        if k not in self._raw:
+                            sub_raw[k] = v  # noqa: PERF403
             self._raw.update(sub_raw)
             self.changed = True  # loading while iterating can cause these values to be missed
             yield from sub_raw.keys()
diff --git a/tests/config/test_set_env.py b/tests/config/test_set_env.py
index f72a23299..2c068f9b5 100644
--- a/tests/config/test_set_env.py
+++ b/tests/config/test_set_env.py
@@ -240,3 +240,51 @@ def test_set_env_environment_file_missing(tox_project: ToxProjectCreator) -> Non
     result = project.run("r")
     result.assert_failed()
     assert f"py: failed with {project.path / 'magic.txt'} does not exist for set_env" in result.out
+
+
+# https://github.com/tox-dev/tox/issues/2435
+def test_set_env_environment_with_file_and_expanded_substitution(
+    tox_project: ToxProjectCreator, monkeypatch: MonkeyPatch
+) -> None:
+    conf = {
+        "tox.ini": """
+        [tox]
+        envlist =
+            check
+
+        [testenv]
+        setenv =
+            file|.env
+            PRECENDENCE_TEST_1=1_expanded_precedence
+
+        [testenv:check]
+        setenv =
+            {[testenv]setenv}
+            PRECENDENCE_TEST_1=1_self_precedence
+            PRECENDENCE_TEST_2=2_self_precedence
+        """,
+        ".env": """
+        PRECENDENCE_TEST_1=1_file_precedence
+        PRECENDENCE_TEST_2=2_file_precedence
+        PRECENDENCE_TEST_3=3_file_precedence
+        """,
+    }
+    monkeypatch.setenv("env_file", ".env")
+    project = tox_project(conf)
+
+    result = project.run("c", "-k", "set_env", "-e", "check")
+    result.assert_success()
+    set_env = result.env_conf("check")["set_env"]
+    content = {k: set_env.load(k) for k in set_env}
+    assert content == {
+        "PIP_DISABLE_PIP_VERSION_CHECK": "1",
+        "PYTHONHASHSEED": ANY,
+        "PYTHONIOENCODING": "utf-8",
+        "PRECENDENCE_TEST_1": "1_expanded_precedence",
+        "PRECENDENCE_TEST_2": "2_self_precedence",
+        "PRECENDENCE_TEST_3": "3_file_precedence",
+    }
+
+    result = project.run("r", "-e", "check")
+    result.assert_success()
+    assert "check: OK" in result.out