diff --git a/heat/engine/resources/stack.py b/heat/engine/resources/stack.py
index 4960f49b0..dc031ab68 100644
--- a/heat/engine/resources/stack.py
+++ b/heat/engine/resources/stack.py
@@ -16,6 +16,7 @@
 from heat.common import exception
 from heat.common import template_format
 from heat.common import urlfetch
+from heat.engine.properties import Properties
 from heat.engine import stack_resource
 
 from heat.openstack.common import log as logging
@@ -38,6 +39,10 @@ class NestedStack(stack_resource.StackResource):
                          PROP_TIMEOUT_MINS: {'Type': 'Number'},
                          PROP_PARAMETERS: {'Type': 'Map'}}
 
+    update_allowed_keys = ('Properties',)
+    update_allowed_properties = (PROP_TEMPLATE_URL, PROP_TIMEOUT_MINS,
+                                 PROP_PARAMETERS)
+
     def handle_create(self):
         template_data = urlfetch.get(self.properties[PROP_TEMPLATE_URL])
         template = template_format.parse(template_data)
@@ -58,6 +63,20 @@ class NestedStack(stack_resource.StackResource):
     def FnGetRefId(self):
         return self.nested().identifier().arn()
 
+    def handle_update(self, json_snippet, tmpl_diff, prop_diff):
+        # Nested stack template may be changed even if the prop_diff is empty.
+        self.properties = Properties(self.properties_schema,
+                                     json_snippet.get('Properties', {}),
+                                     self.stack.resolve_runtime_data,
+                                     self.name)
+
+        template_data = urlfetch.get(self.properties[PROP_TEMPLATE_URL])
+        template = template_format.parse(template_data)
+
+        self.update_with_template(template,
+                                  self.properties[PROP_PARAMETERS],
+                                  self.properties[PROP_TIMEOUT_MINS])
+
 
 def resource_mapping():
     return {
diff --git a/heat/tests/test_nested_stack.py b/heat/tests/test_nested_stack.py
index 3346ca2bd..68a9bcfa5 100644
--- a/heat/tests/test_nested_stack.py
+++ b/heat/tests/test_nested_stack.py
@@ -13,6 +13,8 @@
 #    under the License.
 
 
+import copy
+
 from heat.common import exception
 from heat.common import template_format
 from heat.common import urlfetch
@@ -47,6 +49,16 @@ Outputs:
     Value: bar
 '''
 
+    update_template = '''
+HeatTemplateFormatVersion: '2012-12-12'
+Parameters:
+  KeyName:
+    Type: String
+Outputs:
+  Bar:
+    Value: foo
+'''
+
     def setUp(self):
         super(NestedStackTest, self).setUp()
         self.m.StubOutWithMock(urlfetch, 'get')
@@ -67,9 +79,9 @@ Outputs:
         stack.store()
         return stack
 
-    def test_nested_stack(self):
-        urlfetch.get('https://localhost/the.template').AndReturn(
-            self.nested_template)
+    def test_nested_stack_create(self):
+        urlfetch.get('https://localhost/the.template').MultipleTimes().\
+            AndReturn(self.nested_template)
         self.m.ReplayAll()
 
         stack = self.create_stack(self.test_template)
@@ -80,9 +92,6 @@ Outputs:
                       rsrc.physical_resource_name())
         self.assertTrue(rsrc.FnGetRefId().startswith(arn_prefix))
 
-        self.assertRaises(resource.UpdateReplace,
-                          rsrc.handle_update, {}, {}, {})
-
         self.assertEqual('bar', rsrc.FnGetAtt('Outputs.Foo'))
         self.assertRaises(
             exception.InvalidTemplateAttribute, rsrc.FnGetAtt, 'Foo')
@@ -96,6 +105,44 @@ Outputs:
 
         self.m.VerifyAll()
 
+    def test_nested_stack_update(self):
+        urlfetch.get('https://localhost/the.template').MultipleTimes().\
+            AndReturn(self.nested_template)
+        urlfetch.get('https://localhost/new.template').MultipleTimes().\
+            AndReturn(self.update_template)
+
+        self.m.ReplayAll()
+
+        stack = self.create_stack(self.test_template)
+        rsrc = stack['the_nested']
+
+        original_nested_id = rsrc.resource_id
+        t = template_format.parse(self.test_template)
+        new_res = copy.deepcopy(t['Resources']['the_nested'])
+        new_res['Properties']['TemplateURL'] = 'https://localhost/new.template'
+        prop_diff = {'TemplateURL': 'https://localhost/new.template'}
+        rsrc.handle_update(new_res, {}, prop_diff)
+
+        # Expect the physical resource name staying the same after update,
+        # so that the nested was actually updated instead of replaced.
+        self.assertEqual(original_nested_id, rsrc.resource_id)
+        db_nested = db_api.stack_get(stack.context,
+                                     rsrc.resource_id)
+        # Owner_id should be preserved during the update process.
+        self.assertEqual(stack.id, db_nested.owner_id)
+
+        self.assertEqual('foo', rsrc.FnGetAtt('Outputs.Bar'))
+        self.assertRaises(
+            exception.InvalidTemplateAttribute, rsrc.FnGetAtt, 'Foo')
+        self.assertRaises(
+            exception.InvalidTemplateAttribute, rsrc.FnGetAtt, 'Outputs.Foo')
+        self.assertRaises(
+            exception.InvalidTemplateAttribute, rsrc.FnGetAtt, 'Bar')
+
+        rsrc.delete()
+
+        self.m.VerifyAll()
+
     def test_nested_stack_suspend_resume(self):
         urlfetch.get('https://localhost/the.template').AndReturn(
             self.nested_template)