A local Taliban commander and 50 fighters have been killed in overnight fighting in Sangin in Helmand province, the Afghan interior ministry said.
Afghan forces have been trying to recapture the area from the Taliban, who claim to control the district.
Afghan officials said they retook key buildings in a counter-attack, while the US carried out air strikes.
The ministry named the dead commander as Mullah Nasir, a confidant of Taliban leader Mullah Akhtar Mansour.
Strategically located, and a centre for opium production, Sangin would be a significant gain for the Taliban.
Fighting around the town has escalated in the past week, and by Wednesday the militants said they had captured all of Sangin, pinning down government troops in an army barracks.
This was denied by the Afghan defence ministry, who said fighting was continuing and that reinforcements had been sent.
The interior ministry said the Afghan army and police commandos launched an operation late on Wednesday, leading to the deaths of the Taliban commander and his fighters.
Several local officials said the district governor's office and police headquarters in Sangin's centre had been retaken.
"Last night fresh forces arrived, they provided ammunitions and food to forces at the battalion and launched a counterattack," Helmand senator Hashim Alokozai said.
"They recaptured the district and police HQ and the wounded were evacuated. We hope they will make further progress today."
It remains unclear whether the Taliban were fully in control of Sangin, with Afghan officials giving conflicting information about the state of their advance.
Meanwhile US planes launched two air strikes on Taliban positions shortly before midnight on 23 December, a Nato spokesman said.
Despite the reports of Afghan government gains, the Taliban remain in control of large parts of Helmand.
Sangin residents have been fleeing as the fighting worsened.
A small contingent of British troops has been sent to Helmand "in an advisory role," the British government said on Tuesday.
Sangin saw almost a quarter of British military fatalities during the UK's combat mission in Afghanistan.
In September, the Taliban briefly overran the northern Afghan city of Kunduz in one of their biggest victories since 2001.