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A sensor fault detection and isolation unit is considered for induction-motor drives based on an adaptive observer with rotor-resistance estimation. Generally, closed-loop induction-motor drives with voltage-source inverters use a speed or position, a dc-link voltage, and two or three phase-current sensors. In the proposed fault-detection and isolation unit, the estimated phase currents and rotor resistance are sent to a decision-making unit, which identifies the faulty sensor type based on a deterministic rule base. In the case of a current-sensor failure, it also detects the phase with erroneous sensor output. It is shown that, unlike the other proposed model-based fault-tolerant systems, using a bank of observers is not necessary, and only one current observer with rotor-resistance estimation is sufficient for isolation of all sensors' faults. The accuracy of the proposed approach is analytically proved. Furthermore, extensive simulation and experimental tests verify the effectiveness of the proposed method at different operating conditions.