A local Taliban commander and 50 fighters have been killed in overnight fighting in Sangin in Helmand province, the Afghan interior ministry says.
Government forces have been trying to recapture the area from the Taliban, who say they control the district.
Afghan officials say they have retaken key buildings in a counter-attack, and the US has 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 escalated this 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 are fully in control of Sangin, with Afghan officials giving conflicting information about the state of their advance.
US planes launched two air strikes on Taliban positions shortly before midnight on Wednesday, a Nato spokesman said.
Siddiq Siddiqi, a spokesman for the Afghan interior ministry, denied to the BBC that officials were slow to send reinforcements to Sangin.
A district police commander told the BBC on Monday his officers in Sangin were surrounded, but reinforcements did not arrive until late on Wednesday.
Why Sangin matters
EPA- Sangin is a rich production centre for opium in Helmand province
- Helmand is a major centre of the Taliban insurgency and borders Pakistan
- Of the 456 UK military deaths in Afghanistan from 2001 to 2015, almost a quarter were killed in and around Sangin
- US and British troops have been sent to Helmand in the last few days, but in an advisory role only
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 worsens.
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 Kunduzin one of their biggest victories since 2001
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