More than 100 men entered the town in western Michoacan state on Sunday morning and disarmed local police.
There were exchanges of fire with alleged gang members before the vigilantes occupied the town.
The vigilante group was set up by residents who say the army and the police have failed to protect them.
The Knights Templar has been fighting the New Generation cartel, from neighbouring Jalisco state, for control of criminal activities in the area.
Vigilantes, also known as self-defence groups or community police, have been active in several Mexican states.
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