Habitat partitioning among co-occurring, ecologically similar species is widespread in nature and thought to be an important mechanism for coexistence. The factors that cause habitat partitioning, however, are unknown for most species. We experimentally tested among three alternative hypotheses to explain habitat partitioning among two species of co-occurring burying beetle (Nicrophorus) that occupy forest (N. orbicollis) and wetland (N. hebes) habitats. Captive experiments revealed that the larger N. orbicollis (forest) was consistently dominant to N. hebes (wetland) in competitive interactions for carcasses that they require for reproduction. Transplant enclosure experiments in nature revealed that N. hebes had poor reproductive success whenever the dominant N. orbicollis was present. In the absence of N. orbicollis, N. hebes performed as well, or better, in forest versus its typical wetland habitat. In contrast, N. orbicollis performed poorly in wetlands regardless of the presence of N. hebes. These results support the Competitive exclusion – tolerance rule where the competitively dominant N. orbicollis excludes the subordinate N. hebes from otherwise suitable or preferable forest habitat, while the subordinate N. hebes is uniquely able to tolerate the challenges of breeding in wetlands. Transplant experiments further showed that carcass burial depth – an important trait thought to enhance the competitive ability of the dominant N. orbicollis – is costly in wetland habitats. When in the presence of N. hebes, N. orbicollis buried carcasses deeper; deeper burial is thought to provide a competitive advantage in forests, but further compromised the reproductive success of N. orbicollis in wetlands. Overall, results provide evidence that the Competitive exclusion – tolerance rule underlies habitat partitioning among ecologically similar species, and that the traits important for competitive dominance in relatively benign environments are costly in more challenging environments, consistent with a trade-off.