Sept. 19, 2008  -- A transgendered woman, who lost a job offer because of her sexual status, has won a potentially groundbreaking federal sex discrimination lawsuit.

A federal district court judge in Washington, D.C., ruled today that the Library of Congress discriminated against Diane Schroer when it offered her a job and then rescinded it after learning she was transgendered.

The American Civil Liberties Union, which represented Schroer, said Judge James Robertson's ruling is the first to hold that the federal sex discrimination statute, Title VII of the 1964 Civil Rights Act, applies to transgendered people.

Other courts that have considered the issue have said Congress only intended for the anti-discrimination statute to protect men and women, but not people who change their sex, the ACLU said.

Robertson disagreed, saying Schroer's case "was discrimination based on sex."

"It is tremendously gratifying to have your faith in this country, and what is fundamentally right and fair, be reaffirmed," Schroer said. "I very much hope that this ruling will help to eliminate the all-too-pervasive discrimination against sexually nonconforming people in all areas."

She added, "I hope, too, that employers, family members, friends and co-workers will begin to understand variations in sexual orientation and identity from a basis of knowledge and not fear."

Schroer said she applied for, and was offered, a job at the Library of Congress as David Schroer.

When David went to his first meeting with his soon-to-be boss, Schroer told her that he would be transitioning to a female before starting the job. The next day, the job offer was rescinded, Schroer says.

For more than 25 years, David Schroer was a star in the U.S. Army, rising through the ranks to become a Special Forces commander while leading a classified anti-terrorism unit involved in covert operations.

That all changed when Schroer abruptly retired from the military and made a shocking announcement that stunned both his colleagues and family. He would no longer be Col. David Schroer, because he is now Diane Schroer, a transsexual.

In a 2005 interview with "20/20" Deborah Roberts, Schroer explained why, after decades of service in one of the most dangerous and macho lines of work, she became a woman.

"Does seem a bit of a disconnect," Schroer acknowledged. But, she says, she has struggled with her gender identity -- privately -- since childhood.

"Something was different since even before I can remember. I was always enthralled with things the girls were doing. ... Whenever my parents were gone, I would experiment with my mother's makeup. And wondered why I enjoyed doing that ... Wondered why I couldn't carry a purse," Schroer said.

Painful Internal Battle

Her lawsuit may be precedent-setting, but Dr. George Brown, a military psychiatrist, said Schroer's story is not unique. He said he's treated hundreds of soldiers who are transsexuals. Brown described transsexualism as "a sense that there's been a biological mistake -- that the body doesn't match who you are as a person inside."

Schroer says it was apparent to her from the time she was a child, growing up in Oak Lawn, Ill., just outside Chicago. Her brothers, Gary and Bill, only remember a happy childhood with their little brother, however.

"I think it was probably very much ... the typical American family, three boys growing up. We played baseball. We played in the neighborhood. We rode bikes. We pretty much did what other kids did in the '50s," said Bill Schroer.

Schroer's siblings never knew their little brother was suffering quietly, never daring to mention the anguish inside.

Schroer says growing up as a boy left her feeling uneasy and deeply conflicted about who she really was. "When I hit adolescence, it was, at times, consuming. ... So, I did everything I could to push that out of my mind," she told Roberts.

When David Schroer entered Northern Illinois University, he was in full denial of his gender crisis. He worked as an auto mechanic, an electrician and joined ROTC. After graduation, he entered Special Forces and somehow thrived in the most dangerous of military careers. He even fell in love with a woman and got married.

"We had a normal sexual relationship," Schroer said. "Although, I would say that I would often think of myself being on the other side of the relationship."

Ending Years of Denial

Schroer managed to keep up the act, rising through the ranks of the military. By his mid-40s, he was a Special Forces commander, leading a classified anti-terrorism unit and managing an $8 billion budget. He even briefed Vice President Dick Cheney on secret missions.

But he grew tired of denying what he believed was his true sexual identity.

"I think when I learned enough to understand what it was that I was really feeling ... I could either hide that, or I could acknowledge to the world that I was, in fact, a woman. And receive their acknowledgement back," Schroer told "20/20."

Schroer told his wife first, even hoping there might be a possibility they could stay together. But the couple decided to separate.

Schroer's marriage was over, but he found fulfillment for the first time. He began openly dressing as a woman and calling himself Diane. Schroer was retired at the time, and didn't have to break the news to Washington's top brass. But he began telling his Special Forces buddies, including retired Lt. Col. Dan Bernard.

"The way she explained it to me was by showing me some photos that had been taken of her as a woman in a business kind of setting, wearing makeup and with a big wig and women's clothes. ... And I didn't get mad and I didn't storm out," Bernard said.

"I explained to him about being transgendered and what that meant, and he sat back for a moment and said, 'You really had me scared. Wow, I thought you were going to tell me something bad.' ... It was a tremendous relief," Schroer recalled.

Now, Schroer was confident enough to tell family, nervously breaking the news to Bill and Gary -- still dressed as David.

Even though the news was, and continues to be, difficult to accept, Gary Schroer said there was never a question in his mind about being supportive to his younger brother. "It's still tough. But support and acceptance are two different things," he said.

Schroer then began the long and painful process of becoming a woman, undergoing intense therapy and taking female hormones under medical supervision. He also started wearing makeup, and underwent extensive cosmetic surgery.

In 12 hours of surgery, Schroer said, doctors gave him "a scalp advance, a forehead revision, nose reconstruction, upper lip revision, jaw and chin reshaping, and a tracheal shave." In a tracheal shave, the surgeon reduces the cartilage in the throat to get rid of a masculine-looking Adam's apple.

The genital reassignment surgery would come later. But in the meantime, Schroer was already looking more feminine and beginning to envision a new relationship.

But Schroer wasn't envisioning a sexual relationship with any men. Schroer is interested in dating women. "I would say I am, in fact, a lesbian," she said.

Schroer's desire to be with women is not uncommon for transsexuals. Brown says gender identity and sexual preference are two entirely different things.

"If sex and gender were the same, then that would make no sense at all. Sexuality is who you're attracted to. Gender is who you are as a person, male or female. So, the surgery and the transition is all about matching the mind with the body. It has nothing to do with sexuality," Brown said.

At Center of Landmark Gender Discrimination Suit

While Schroer is grateful to have the acceptance of her family, she has encountered challenges in her public life. While still transitioning to become female, Schroer applied for, and was offered, a job as a terrorism analyst at the Library of Congress late last year.

Because she was still legally David Schroer, she did not reveal her plans to her prospective employer during the interview.

She decided to tell the woman who hired her that she would begin work as a woman, not a man. Schroer said it seemed as though the woman took the information in stride and that the hiring was going forward as planned.

But the following day, Schroer said she was told that she was no longer "a good fit" for the position. Schroer and her brothers were furious.

The Library of Congress first agreed to an interview with "20/20," but then declined, citing Diane's lawsuit. In an e-mail, they wrote that they "acted appropriately and complied with the law" and that "claims such as those raised by Ms. Schroer ... are not covered under Title VII of the Civil Rights Act" or the U.S. Constitution.

While waiting for her day in court and looking for a full-time job, Schroer's deepest fears concerned her family who had yet to see her as a woman. In July, Schroer allowed "20/20" cameras to film her first visit as a sister with her family in suburban Chicago.

The family was understandably surprised by the dramatic change in her appearance, but before long, the brothers were reminiscing about their childhood. For Gary and Bill Schroer, the memories are bittersweet as they feel, in a sense, they've lost a brother while gaining a new sister.

For Schroer, the childhood memories have a far different meaning. She's always known that inside that little boy lived a little girl who longed to grow up and become a woman. "What's great about my life now is that it's unified, it's focused and this huge distraction that was in my life is now gone."