The 22-year-old, who has been used primarily at right-back since making his debut in 2009, has made 54 first-team appearances for the Merseyside club.
"I'm delighted to have signed. It means everything to me and my family. I've been at Liverpool since I was seven, so it's in my heart and I love the club," Kelly said on the club website.
"Being a Liverpool supporter myself, it's brilliant to put the shirt on and I'm doing what I have loved doing since I was a kid. I'm over the moon."
Kelly, who has one England cap and was part of the country's Euro 2012 squad, has suffered with injuries throughout his fledgling career and has been out of action this season since injuring his knee against Manchester United in September.
"Today shows the faith that the club have in me and that the hard work I have put in since I was young has paid off," he added.
"Hopefully I'll put the injuries behind me. We have excellent medical staff here, who are going to work me and keep me on top of my injury. I'll be coming back even stronger."
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