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At a basic level, it teleports the casting hero to the nearest allied town. However, if the hero has Advanced or Expert Earth Magic, Town Portal teleports the hero to any allied town, at the players choice. The hero cannot teleport to a town which has a visiting hero, thus, if the hero doesn't have at least Advanced Earth Magic and the nearest town is occupied, spell cannot be cast. If there is a hero in the garrison but no visiting one, the town can be reached by the spell.
It is possible, that in some versions of the game, that hero is unable to use Town Portal spell underground if all towns are in the upper world, and if the hero has no Earth Magic at least on the Advanced level.
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Town Portal is possibly the most powerful spell in the game. It is severely imbalanced as it allows hero to travel immense distances instantaneously. Hero with Town Portal can hire great amount of troops, upgrade them and take them far away simultaneously, will have a great chance to defend a town with no losses if an enemy hero comes close (sometimes the strongest hero is far from home, and there's a low level hero near the starting town, but Town Portal solves this problem), afterwards getting to a town which is on the other edge of the map and close to enemy towns. The hero can learn all spells and, if possible, improve primary skills, get experience in Dungeon and learn Magic Schools in Conflux, visit adventure map locations (creature banks, primary skill modifiers, Seer's Huts, shrines), give troops or artifacts to another hero. The only downside of that travelling is wasting spell points, but it often makes almost no sense as their maximum amount can easily exceed 100 - if an enemy tries to besiege the town, the defender has an advantage of fortifications and Arrow Towers, and if not, spell points are reloaded.
If you lose a town with Town Portal in the Mage Guild, it may be fatal as since then, your enemy will be able to travel anywhere. Also, sometimes the desired town is occupied by two heroes (both the in garrison and the visiting one) - simply move the visiting hero somewhere, or even fire this hero if he or she doesn't have high stats, proper secondary skills and good spells. However, the spell is so powerful that it should be banned in multiplayer or tournament games (unless Earth Magic is banned at all, as mass Slow and permanent Resurrection is also a big imbalance).