Transposable elements (TEs) are parasitic DNA sequences that insert into the host genome and can cause alterations in host gene structure and expression. Host organisms cope with the often detrimental consequences caused by recent transposition and develop mechanisms that repress TE activities. In the nematode Caenorhabditis elegans, a small interfering RNA (siRNA) pathway dependent on the helicase ERI-6/7 primarily silences long terminal repeat retrotransposons and recent genes of likely viral origin. By studying gene expression variation among wild C. elegans strains, we discovered that structural variants and transposon remnants at the eri-6/7 locus alter its expression in cis and underlie a trans-acting expression quantitative trait locus affecting non-conserved genes and pseudogenes. Multiple insertions of the Polinton DNA transposon (also known as Mavericks) reshuffled the eri-6/7 locus in different configurations, separating the eri-6 and eri-7 exons and causing the inversion of eri-6 as seen in the reference N2 genome. In the inverted configuration, gene function was previously shown to be repaired by unusual trans-splicing mediated by direct repeats flanking the inversion. We show that these direct repeats originated from terminal inverted repeats specific to C. elegans Polintons. This trans-splicing event occurs infrequently compared to cis-splicing to novel downstream exons, thus affecting the production of ERI-6/7. Diverse Polinton-induced structural variations display regulatory effects within the locus and on targets of ERI-6/7-dependent siRNA pathways. 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.