The 24-year-old made his Reds debut back in 2009 but found first-team opportunities limited, with a serious knee injury also ruling him out for a year.
Kelly, capped once by England in a 2012 friendly against Norway, becomes Eagles manager Tony Pulis' fourth signing of the summer following the acquisitions of Chris Kettings, Fraizer Campbell and Brede Hangeland.
Confirming the move on their official website, the south London club wrote: "Crystal Palace are delighted to confirm the signing of versatile defender Martin Kelly from Liverpool for an undisclosed fee.
"The once capped England international, 24, has put pen to paper on a three-year deal at Selhurst Park after passing a medical last night.
"He will wear the number 34 shirt for the Eagles and could make his debut for the club on the opening day of the Barclays Premier League season at Arsenal this weekend."
Kelly, a lifelong Liverpool fan, paid tribute to those who allowed him to play at Anfield and is now looking forward to a fresh challenge at Palace.
"I would like to thank all the managers at LFC for making my wish from the age of 7 come true - playing for 1 of the biggest clubs in the world," he tweeted.
"Most of all would like to thank the fans for supporting me since my home debut against Lyon in Oct 2009 even through injuries always by my side.
"Now to start a new chapter of my football career at Crystal Palace a great club with unbelievable fans - excited already for the weekend."
Pulis may have been quieter than predecessor Ian Holloway in the transfer market but he will still be hoping to add further new faces before the close of the window - Stoke midfielder Steven N'Zonzi and Southampton's Jack Cork have been linked with moves to Selhurst Park.
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