The regulator says looked-after children face serious problems with education and health care because agencies are failing to work together.
Around one in 10 children in care in England is moved more than 20 miles from their home area.
The Local Government Association says it finds the report "disappointing".
Ofsted found that 8,000 (12%) of looked-after children live more than 20 miles from their home.
The regulator concedes that this might sometimes be in the best interests of a child.
However, it says the most common reason for children to live out of their home area was a shortage of carers closer to home.
Inspectors saw many cases where children were well-settled in their placements, and examples of good practice from individual social workers, who worked well to establish beneficial relationships, maintaining regular contact with young people despite the long distances involved.
But they concluded that the further away from home children live, the less likely it is that their health and education needs will be met.
In nearly half the cases tracked, children and young people arrived in new areas without the right specialist support being in place for them, with poor information sharing leading to potentially damaging delays in their care.
In a third of cases, the quality of the support and help offered by services out of area had not been properly considered.
Debbie Jones, Ofsted's national director for social care, said this meant young people in care often experienced problems with their education, and delays accessing mental health services.
"Becoming looked after is difficult enough for any young person, even more so when they move away from their family, friends, and familiar surroundings to a unfamiliar place, without proper access to the help and support they so desperately need.
"Given the serious risks sometimes associated with out-of-area placements, corporate parents must prioritise and understand the needs of this group.
"The delays for children and young people accessing the mental health support they need, often because of funding disputes between local authorities is frankly unacceptable, and should immediately be resolved as we have recommended.
"As demand continues to grow, more and more children will find themselves placed at distance from their families and communities.
"This issue is not going to go away," she said.
Ofsted is calling on the government to review the impact of strengthened regulations on children's homes providers and local authorities, to ensure that the risks to, and needs of children and young people are properly met and regularly reviewed by those with responsibility for them.
The report comes only weeks after a committee of MPs warned young people were being sent to children's homes in "unsuitable and dangerous areas".
The Local Government Association, which represents councils in England and Wales, said it was "disappointed" by the report.
David Simmonds, chairman of the LGA's children and young people board, said: "Councils have been working very closely with the Department for Education on this issue for some time, in close consultation with approved children's home and foster carers who provide the majority of places.
"This is why it is disappointing that Ofsted are jumping on the bandwagon again with this, rather than offering constructive suggestions, especially as Ofsted is directly responsible for inspecting children's homes' provision.
The biggest concern for councils is the welfare of the children they care for, and the flexibility to place children away from the area where abuse or neglect has brought them into the care system can be a vital way of giving them a new beginning away from these problems.
"There are very good reasons why some children in residential homes are placed outside their home area. This could be for their own safety, to break gang affiliation, to place them near other family members or to access specialist services.
"Residential children's homes play an important role in caring for some of the most vulnerable children in society at difficult times in their lives and councils have a key role in making this happen."
A Department for Education official said that "every child deserves a safe and stable home.
"We have been clear that children should only be placed out of area when it is in their best interest. We have already changed the rules so that any such decision must be approved by a senior council official.
"We have also increased transparency about the location and quality of children's homes, and are working closely with Ofsted to improve inspection.
"There are now clearer expectations for children's homes, police and councils to ensure they work closely together when children are at risk of going missing."