A system is provided that enables efficient traffic forwarding in a hypervisor. During operation, the hypervisor determines that a packet is from a first virtual machine (VM) running on the hypervisor and destined to a second VM running on a remote hypervisor. The hypervisor then includes a virtual local area network (VLAN) identifier of a transit VLAN (TVLAN) in a layer-2 header of the packet. The TVLAN is dedicated for inter-VM traffic associated with a distributed virtual routing (DVR) instance operating on the hypervisor and the remote hypervisor. Subsequently, the hypervisor sets a first media access control (MAC) address of the hypervisor as a source MAC address and a second MAC address of the remote hypervisor as a destination MAC address in the layer-2 header. The hypervisor then determines an egress port for the packet based on the second MAC address.