It is crucial to understand the degradation mechanisms of alloy Zr-2.5Nb, which is used for the pressure boundary in Canada Deuterium Uranium (CANDU®) reactors. In this study, Zr-2.5Nb coupons were exposed for 567 days at 325 °C with and without neutron-irradiation in simulated primary water chemistry. A combination of scanning/transmission electron microscopy and electron energy loss spectroscopy was used to investigate oxide layer chemistry and microstructure. The non-irradiated oxide layer exhibited equiaxed-columnar-equiaxed grains and interconnected nanopores, whereas the irradiated oxide showed a sporadic distribution of equiaxed-columnar grains and isolated nanopores. The nanopores may create pathways for the diffusion of hydrogen or ions through the oxide film. Nb oxidation state variation was correlated with nanopore density from the metal–oxide interface to the oxide–water interface; this likely resulted in a gradient in the oxygen concentration and electrochemical potential through the film. Subsequent micropillar compression tests on the oxide layer revealed subtle changes in the mean failure stress, whereas the mean failure strain remains the same for samples exposed for 1399 and 1750 days. Post-deformation characterization confirmed that the failure of the oxide layer is brittle and could be pseudo-shear, which is consistent with the critical failure mode for brittle materials and supported by finite element analysis. Further, TEM characterization confirmed transgranular cracking in the oxide layer during deformation.