"The bodies were in (the) debris of the plane and buildings... we are taking the bodies one by one by ambulance to (a nearby) hospital," said local police chief Mardiaz Dwihananto.
"The bodies have been crushed by debris of the building and the fuselage."
The plane crashed into the newly-constructed residential area, although it was unclear whether it was occupied by residents yet. Police have cordoned off the area.
"A Hercules was... transporting military equipment from Medan," military spokesman Fuad Basya told AFP.
The plane took off 12:08 pm (0508 GMT) from an air force base and crashed in the city about two minutes later, about five kilometres (three miles) from the base, he said.
Asked about potential casualties, Basya said: "We don't know for sure but inside there will be the plane crew, pilot, but I don't know how many."
"It crashed near a residential area and caught fire," search and rescue agency official Tatang Zainuddin told AFP.
"We have asked our search and rescue office in Medan to immediately go to the site for evacuation of any victims."
The Indonesian air force has suffered accidents before.
In April, an F-16 fighter jet caught fire as it was about to take off from an airbase in Jakarta, prompting the pilot to jump to safety as flames and thick smoke engulfed the plane.
The pilot escaped with minor injuries from the jet which had been due to provide security at a summit of Asian and African leaders in Indonesia.
That came a month after two air force planes from an Indonesian aerobatics team crashed during a practice session ahead of an air show on Malaysia's Langkawi island. All four pilots ejected successfully and survived.
Indonesia also has a poor civil aviation safety record. An Indonesia AirAsia plane crashed in December en route from Indonesia's Surabaya to Singapore, killing all 162 people on board.