diff --git a/tests/overlay_overlay_local_merge.dts b/tests/overlay_overlay_local_merge.dts
new file mode 100644
index 0000000..3ee622d
--- /dev/null
+++ b/tests/overlay_overlay_local_merge.dts
@@ -0,0 +1,29 @@
+/*
+ * Copyright (c) 2016 NextThing Co
+ * Copyright (c) 2016 Free Electrons
+ * Copyright (c) 2016 Konsulko Inc.
+ *
+ * SPDX-License-Identifier:	GPL-2.0+
+ */
+
+/dts-v1/;
+/plugin/;
+
+&test {
+	parent: new-node {
+		parent-property;
+	};
+};
+
+&parent {
+	new-merged-property;
+	new-merged-node {
+		new-property;
+	};
+};
+
+&{/} {
+	new-root-node {
+		new-root-node-property;
+	};
+};
diff --git a/tests/run_tests.sh b/tests/run_tests.sh
index 6756f3d..e3e64e8 100755
--- a/tests/run_tests.sh
+++ b/tests/run_tests.sh
@@ -257,6 +257,11 @@ dtc_overlay_tests () {
     run_test check_path overlay_overlay_bypath.test.dtb not-exists "/__fixups__"
     run_test check_path overlay_overlay_bypath.test.dtb exists "/__local_fixups__"
 
+    # Make sure local target references are resolved and nodes are merged and that path references are not
+    run_dtc_test -I dts -O dtb -o overlay_overlay_local_merge.test.dtb overlay_overlay_local_merge.dts
+    run_test check_path overlay_overlay_local_merge.test.dtb exists "/fragment@0/__overlay__/new-node/new-merged-node"
+    run_test check_path overlay_overlay_local_merge.test.dtb exists "/fragment@1/__overlay__/new-root-node"
+
     # Check building works the same as manual constructions
     run_test dtbs_equal_ordered overlay_overlay.test.dtb overlay_overlay_nosugar.test.dtb