Fighting began when Iraqi troops and Shia militias entered Altun Kupri in an operation "to impose law and order," according to the Iraqi military.
Clashes were still ongoing in the northern part of the town. Altun Kupri -- a multi-ethnic town made up of Kurds, Turkmen and Arabs -- is located about 20 miles north of Kirkuk.
Iraqi army units control the Batma and Ein-Zala oil fields and a total of 44 oil wells, Iraqi Joint Operations Command said in a statement. The army also controls the Zammar and Ayn Zala districts in the northwest Ninawa province, the statement said.
An eyewitness told CNN that Peshmerga forces were using light and heavy machine guns and mortars.
"This is the beginning of the war between the Kurds and Baghdad," Goran Iz Al-Din, a Peshmerga commander, told CNN.
"We don't want to be ruled by Iran," he added, a reference to the fact that some of Iraq's Shia militias -- known as Popular Mobilization Units -- are backed by Tehran.
The military actions displaced at least 100,000 people, a news release from the Kurdistan Region Security Council said.
The release said Peshmerga forces destroyed 10 US Humvees and two tanks, including an M1 Abrams tank -- weapons "given to Iraq for the war on Islamic State."
Iraqi forces seized the coveted oil-rich city of Kirkuk
on Monday after three years under Kurdish control.
The Kurds had gained control of the city after Iraqi government forces abandoned it during ISIS' offensive in 2014.
The Kurdistan region and the greater Kirkuk province have an estimated 15% to 25% of Iraq's oil reserves, with several key oil fields surrounding the city of Kirkuk. Iraq has one of the world's largest known oil reserves.
Kirkuk was historically a Kurdish-majority town, but during the rule of Saddam Hussein, the ousted dictator moved Arab families in and Kurdish families
out to change the area's ethnography, under a policy termed "Arabization." It's also home to Sunni Arabs and Turkmen.
Extremists, including al Qaeda in Iraq, have launched major attacks on Kirkuk over the past decade, targeting mostly security forces there.
After the fall of Hussein, Kurds began returning to Kirkuk, repopulating the city and its surrounding areas.
Kurdistan resident Masoud Barzani issued a statement Friday urging the international community to speak out "to impede the occurrence of another genocide against the people of Kurdistan who are now living under the oppression of the Iraqi government."
On Friday, the US State Department said the Iraqi government should calm the situation in Kirkuk by coordinating with the Kurdistan Regional Government to to limit the movements of Iraqi forces in disputed areas.
"The reassertion of federal authority over disputed areas in no way changes their status -- they remain disputed until their status is resolved in accordance with the Iraqi constitution," the US statement said. "Until parties reach a resolution, we urge them to fully coordinate security and administration of these areas."