You are exactly correct. It really irritates me when modifiers like "only" are placed in the wrong position in English sentences. IT SHOUD BE ...smoke only outside...!!! ..We can only smoke outside... is usually understood to mean that "smoking is not allowed inside", but for this meaning to be clear the word "outside" has to be emphasized. Without the emphasis on "outside" it means that "nothing except smoking is allowed outside". In this case the emphasis is normally put on the word "smoke", but it is not necessary for the meaning to be clear.
This is not correct in English. It means "we can't dance, we can't sing, we can only smoke outside the hotel." It should be "We can smoke only outside the hotel" but it was marked incorrect. Since a lot of ignorant people use their incorrect version, I don't mind that they accept it--but I don't like that they don't also accept the correct version.
Duoligo insists on the LEAST grammatically correct translation. The two correct translations are "We only can smoke outside the hotel" and "We can smoke only outside the hotel". The translation Duolingo insists on actually is grammatically incorrect even though it is very common to split verbs. All 3 translations should be accepted.