The effect of sensor faults in direct torque control(DTC) based induction motor drives is analyzed and a new Instrument fault detection isolation scheme(IFDIS) is proposed. The proposed IFDIS, which operated in real-time, detects and isolates the incipient fault(s) of speed sensor and current sensors that provide the feedback information. The scheme consists of an adaptive gain scheduling observer as a residual generator and a special sequential test logic unit. The observer provides not only the estimate of stator flux, a key variable in DTC system, but also the estimates of stator current and rotor speed that are useful for fault detection. With the test logic, the IFDIS has the functionality of fault isolation that only multiple estimator based IFDIS schemes can have. Simulation results for various type of sensor faults show the detection and isolation performance of the IFDIS and the applicability of this scheme to fault tolerant control system design.