The Academy Award winner spoke about the film, which would have been a follow-up to the hit 1992 original starring Costner and Whitney Houston, during a recent episode of "The Howard Stern Show."
"I never made that movie because I could not replace Princess Di," he told Stern.
Costner said it was Sarah Ferguson, Duchess of York, who put them in touch.
"I said, 'Look, I'm going to do 'Bodyguard 2' and I think I can build this around you. Would you be interested?'" he recalled telling Diana. "And she said ... she goes, 'Yes.'"
Costner claimed the conversation took place around 1996, when Diana was on the brink of an official divorce from then-Prince Charles, and that she told him she was ready to try something new.
"She goes, 'My life's about to change,'" he recalled. "She said, 'Is there going to be a kissing scene?' And I said, 'Do you want there to be one?' And she said, 'Yeah.' And I said, 'Then we'll do that.'"
Before production on the movie could begin, Diana died in a car crash on Aug. 31, 1997, at the age of 36, while fleeing the paparazzi in Paris.
Costner claimed Buckingham Palace denied Diana's involvement in the film following her death.
"It leaked out that I had been prepping 'Bodyguard 2' with her," he said. "And what happened was the royal family kind of turned on me a little bit."
Costner said he had a conversation with Prince William years later.
"He looked at me and he said, 'My mom fancied you,'" he recalled. "And it was the sweetest, gentlest thing."
The royal family has not commented on Costner's statements about Diana.