Five Marines had been rescued from the crash site and flown to a hospital in Darwin in a "serious condition", the US officials said, while Australian police said they were triaging the rest of the injured crew at the scene.
"There were a total of 23 personnel on board," US military officials said in a statement.
"Three have been confirmed deceased while five others were transported to Royal Darwin Hospital in a serious condition."
Rescue efforts were complicated by the location of the crash -- the remote and sparsely populated Melville Island about 60 kilometres (37 miles) north of the Australian mainland.
"Recovery efforts are ongoing," US officials said, adding that an investigation into the cause of the incident had been launched.
Prime Minister Anthony Albanese described the incident as "tragic" and "regrettable" but stressed that authorities were still trying to piece together what happened.
"We want to make sure that any information that is provided is absolutely accurate," he told reporters.
The Osprey -- a mix between a helicopter and a plane -- was taking part in the Predators Run exercises, a joint series of warfighting drills involving thousands of soldiers from the US and Australia, as well as other militaries such as Indonesia and the Philippines.
Northern Australia has become an increasingly important staging ground for the US military in recent years, as Washington and Canberra work together to counter China's growing clout in the Asia-Pacific region.
The Osprey aircraft has a troubled history, blighted by a string of fatal crashes over the years.
Four US Marines were killed in Norway last year when their V-22B Osprey aircraft went down during NATO training exercises.
Three Marines were killed in 2017 when an Osprey crashed after clipping the back of a transport ship while trying to land at sea off Australia's north coast.
And 19 Marines died in 2000 when their Osprey crashed during drills in Arizona.
The US Army earlier this year temporarily grounded all pilots who were not involved in critical missions, forcing them to complete further training after a series of safety incidents.
Ospreys are rapidly quick tilt-rotor aircraft that combine the features of both helicopters and turboprop planes, according to the US Air Force.
The hybrid aircraft has two swivelling engines positioned on fixed wingtips that allow it to land and take off vertically, but also travel much faster than a conventional helicopter.
Sunday's incident follows a fatal training crash last month, in which four Australians died when their Taipan helicopter plunged into the sea during a series of multinational war games in Queensland.
The Taipan had been taking part in the large-scale Talisman Sabre exercise, which brought together 30,000 military personnel from Australia, the United States and several other nations.
It crashed near the Whitsunday Islands while taking part in a nighttime operation.
