Faults within layered basaltic sequences significantly influence hydrothermal fluid flow in shallow geothermal reservoirs and potentially during CO2 sequestration and storage. Nevertheless, their characterization regarding fault zone architecture, fluid flow, deformation mechanisms, and seismic potential remains underdeveloped. This study addresses this gap by integrating structural and microstructural observations with X-ray diffraction analyses of exposed normal-transtensional faults associated with the seismically active Húsavík-Flatey Fault in the Tjörnes Fracture Zone, Northern Iceland. Our findings demonstrate that the evolution of basalt-hosted normal-transtensional faults progresses through distinct stages: (1) low-displacement fault propagation from pre-existing cooling joints; (2) fault linkage via dilational jogs; (3) damage zone/fault core growth through brecciation and cataclastic processes; (4) shear localization along sharp slip surfaces; and (5) smearing of volcaniclastic interbeds along the principal fault plane. Evidence of shear localization, truncated clasts, and hydrothermal breccias/veins suggests repeated seismic slip events facilitated by overpressured fluids. Conversely, the presence of clay-rich foliated cataclasite indicates aseismic slips during interseismic periods. Slip along fault jogs, bends, geometric irregularities, and orientation changes causes the dilatant opening of the fault planes and extensional horsetail fractures at fault tips. These structures create main tabular zones for lateral movement of hydrothermal fluids parallel to the fault strike in shallow geothermal reservoirs situated in active extensional-transtensional tectonic settings. In addition, the dilational jogs and the intersection of horsetail veins with the hosting faults may define linear zones of high structural permeability and intense localized fluid flow parallel to the σ2 paleostress orientation and finally mineral precipitation. The results of this study can be utilized to improve models of geothermal fluid flow for enhanced recovery in basaltic reservoirs and assess seismic risk in basaltic faults.