Background Recent analysis of the human and mouse genomes has shown that a substantial proportion of protein coding genes and cis-regulatory elements contain transposable element (TE) sequences, implicating TE domestication as a mechanism for the origin of genetic novelty. To understand the general role of TE domestication in eukaryotic genome evolution, it is important to assess the acquisition of functional TE sequences by host genomes in a variety of different species, and to understand in greater depth the population dynamics of these mutational events. Results Using an in silico screen for host genes that contain TE sequences, we identified a set of 63 mature "chimeric" transcripts supported by expressed sequence tag (EST) evidence in the Drosophila melanogaster genome. We found a paucity of chimeric TEs relative to expectations derived from non-chimeric TEs, indicating that the majority (~80%) of TEs that generate chimeric transcripts are deleterious and are not observed in the genome sequence. Using a pooled-PCR strategy to assay the presence of gene-TE chimeras in wild strains, we found that over half of the observed chimeric TE insertions are restricted to the sequenced strain, and ~15% are found at high frequencies in North American D. melanogaster populations. Estimated population frequencies of chimeric TEs did not differ significantly from non-chimeric TEs, suggesting that the distribution of fitness effects for the observed subset of chimeric TEs is indistinguishable from the general set of TEs in the genome sequence. Conclusion In contrast to mammalian genomes, we found that fewer than 1% of Drosophila genes produce mRNAs that include bona fide TE sequences. This observation can be explained by the results of our population genomic analysis, which indicates that most potential chimeric TEs in D. melanogaster are deleterious but that a small proportion may contribute to the evolution of novel gene sequences such as nested or intercalated gene structures. Our results highlight the need to establish the fixity of putative cases of TE domestication identified using genome sequences in order to demonstrate their functional importance, and reveal that the contribution of TE domestication to genome evolution may vary drastically among animal taxa.