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Transposable elements (TEs) can alter host gene structure and expression, whereas host organisms develop mechanisms to repress TE activities. In the nematodeCaenorhabditis elegans, a small interfering RNA pathway dependent on the helicase ERI-6/7 primarily silences retrotransposons and recent genes of likely viral origin. By studying gene expression variation among wildC. elegansstrains, we found that structural variants and transposon remnants likely underlie expression variation ineri-6/7and the pathway targets. We further found that multiple insertions of the DNA transposons,Polintons,reshuffled theeri-6/7locus and induced inversion oferi-6in some wild strains. In the inverted configuration, gene function was previously shown to be repaired by unusual trans-splicing mediated by direct repeats. We identified that these direct repeats originated from terminal inverted repeats ofPolintons. Our findings highlight the role of host-transposon interactions in driving rapid host genome diversification among natural populations and shed light on evolutionary novelty in genes and splicing mechanisms.