The Block cracks around a water jacket due to a casting imperfection from the factory the water jacket is offset in the block, unfortunately the thin wall cracks and the slight expansion allows the sleeve which is press fit to drop ever so slightly, the tap you hear is the piston lifting the liner up/down and it making contact with the head and block..
Coolant finds its way through the crack and either makes it way up through the headgasket or down in to the sump.
Once the block is cracked there is no going back, it is scrap ready to be turned in to a fancy table.
A new recon engine is your best bet fitting a diesel engine whether that be an M51 or M57 out of a Diesel P38 or 325TDS bmw will be an unnecessary farce and will end up more expensive in the long run, a recon V8 will drop right in..
A top Hat liner is a liner with a Lip that is machined to fit flush with the deck of the block and is used to prevent the slipped liner issue that can become an issue with a non cracked V8 block, this usually happens if you happen to cook the motor and the ally block expands away from the liner which again causes the characteristic tap tap slipped liner sometimes without a water loss issue..
The lip is clamped down by the head and corrects the issue so long as it isn't a crack.