diff --git a/internal/exec/shell_utils.go b/internal/exec/shell_utils.go
index e585e6a08..0e73da870 100644
--- a/internal/exec/shell_utils.go
+++ b/internal/exec/shell_utils.go
@@ -9,6 +9,7 @@ import (
 	"os/exec"
 	"path/filepath"
 	"runtime"
+	"strconv"
 	"strings"
 	"text/template"
 
@@ -150,6 +151,40 @@ func execTerraformShellCommand(
 	workspaceName string,
 	componentPath string) error {
 
+	atmosShellLvl := os.Getenv("ATMOS_SHLVL")
+	atmosShellVal := 1
+	if atmosShellLvl != "" {
+		val, err := strconv.Atoi(atmosShellLvl)
+		if err != nil {
+			return err
+		}
+		atmosShellVal = val + 1
+	}
+	if err := os.Setenv("ATMOS_SHLVL", fmt.Sprintf("%d", atmosShellVal)); err != nil {
+		return err
+	}
+
+	// decrement the value after exiting the shell
+	defer func() {
+		atmosShellLvl := os.Getenv("ATMOS_SHLVL")
+		if atmosShellLvl == "" {
+			return
+		}
+		val, err := strconv.Atoi(atmosShellLvl)
+		if err != nil {
+			u.LogWarning(cliConfig, fmt.Sprintf("Failed to parse ATMOS_SHLVL: %v", err))
+			return
+		}
+		// Prevent negative values
+		newVal := val - 1
+		if newVal < 0 {
+			newVal = 0
+		}
+		if err := os.Setenv("ATMOS_SHLVL", fmt.Sprintf("%d", newVal)); err != nil {
+			u.LogWarning(cliConfig, fmt.Sprintf("Failed to update ATMOS_SHLVL: %v", err))
+		}
+	}()
+
 	componentEnvList = append(componentEnvList, fmt.Sprintf("TF_CLI_ARGS_plan=-var-file=%s", varFile))
 	componentEnvList = append(componentEnvList, fmt.Sprintf("TF_CLI_ARGS_apply=-var-file=%s", varFile))
 	componentEnvList = append(componentEnvList, fmt.Sprintf("TF_CLI_ARGS_refresh=-var-file=%s", varFile))
diff --git a/website/docs/cli/commands/terraform/terraform-shell.mdx b/website/docs/cli/commands/terraform/terraform-shell.mdx
index 7fe8d7609..3d8c0a646 100644
--- a/website/docs/cli/commands/terraform/terraform-shell.mdx
+++ b/website/docs/cli/commands/terraform/terraform-shell.mdx
@@ -39,6 +39,10 @@ The command does the following:
 
 - Inside the shell, the user can execute all `terraform` commands using the native syntax
 
+- Atmos sets the `ATMOS_SHLVL` environment variable to track the nesting level of shells:
+    - If `ATMOS_SHLVL` is not already set, Atmos initializes it to `1`.
+    - If `ATMOS_SHLVL` is already set, Atmos increments its value by `1` for each new nested shell.
+
 :::tip
 Run `atmos terraform shell --help` to see all the available options
 :::