Here’s a quick step-by-step to a nerve racking and otherwise mysterious process.
If you’re engaged in link building but find yourself slipping deeper and deeper into the Google SERP’s for search phrases you have historically ranked well for it might be time to clean out some spammy or over-optimized links. To do this go here www.google.com/webmasters/tools/disavow-links-main and follow the below steps. For direction straight from Google, you can also visit here http://support.google.com/webmasters/bin/answer.py?hl=en&answer=2648487
First download the links to your site into excel sheets. You could start in webmaster tools itself and fortify that data with a number of other tools, e.g. open site explorer.
Once you got that, CAREFULLY decide which links you’re going to disavow and put them into a .txt file that’s formatted properly. Here’s two shots of properly formatted disavow .txt files; one’s an example from Google and the latter is a real life one that we used here for a client:

and a real life example

(note sub domains are treated as unique and there is no wildcard for sub domains so they need entered separately).
Now it’s time to submit the file to Google.
Go here https://www.google.com/webmasters/tools/disavow-links-main
It will look like this

Select the property you want to manage from the drop down and click the red button. You will go to the next screen, which looks like this:

Don’t have anxiety about this screen (I did the first time). Nothing happens when you click the button except for you go to the next screen, which looks like this:

From this screen click choose file and browse to that .txt file you created. Select the file and click submit. The result is a little anti-climactic. You’ll be taken to the next screen, which looks like this:

If you see this screen and the file that you selected is showing (as mine is here) then Google has received the file. If you want to edit the file at some point in the future, just go back to the link I mentioned at the beginning of the process, select the web property you want to manage, get through the couple of screens I’ve shown you and you’ll eventually be brought back here. Then you can just download the file, edit it and upload back to them. I hope this has been helpful. Happy disavowing!