Localization of the stress-induced martensitic phase transformation plays an important role in the fatigue behavior of shape memory alloys (SMAs). The phenomenon of return-point memory that is observed during the subloop deformation of a partially-transformed SMA is a clear manifestation of the interaction between localized phase transformation and degradation of the functional properties. The present study aims to demonstrate this structure–material interaction in the modeling of return-point memory. It seems that this crucial aspect has been overlooked in previous modeling studies. For this purpose, we developed a gradient-enhanced model of pseudoelasticity that incorporates the degradation of functional properties in its constitutive description. The model is employed to reproduce the hierarchical return-point memory in a pseudoelastic NiTi wire under isothermal uniaxial tension with nested subloops. Additionally, a detailed analysis is carried out for a NiTi strip with more complex transformation pattern. Our study highlights the subtle morphological changes of phase transformation under different loading scenarios and the resulting implications for return-point memory.